Did General Dynamics Corporation (NYSE:GD) Create Value For Shareholders?

The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and looking to gauge the potential return on investment in General Dynamics Corporation (NYSE:GD).

With an ROE of 25.04%, General Dynamics Corporation (NYSE:GD) outpaced its own industry which delivered a less exciting 13.69% over the past year. Though, the impressiveness of GD’s ROE is contingent on whether this industry-beating level can be sustained. A measure of sustainable returns is GD’s financial leverage. If GD borrows debt to invest in its business, its profits will be higher. But ROE does not capture any debt, so we only see high profits and low equity, which is great on the surface. But today let’s take a deeper dive below this surface. See our latest analysis for General Dynamics

What you must know about ROE

Return on Equity (ROE) weighs General Dynamics’s profit against the level of its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.25 in earnings from this. Investors seeking to maximise their return in the Aerospace and Defense industry may want to choose the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as accumulating high interest expense.

ROE is measured against cost of equity in order to determine the efficiency of General Dynamics’s equity capital deployed. Its cost of equity is 9.62%. Since General Dynamics’s return covers its cost in excess of 15.42%, its use of equity capital is efficient and likely to be sustainable. Simply put, General Dynamics pays less for its capital than what it generates in return. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. Asset turnover reveals how much revenue can be generated from General Dynamics’s asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. We can determine if General Dynamics’s ROE is inflated by borrowing high levels of debt. Generally, a balanced capital structure means its returns will be sustainable over the long run. We can examine this by looking at General Dynamics’s debt-to-equity ratio. The most recent ratio is 55.03%, which is sensible and indicates General Dynamics has not taken on too much leverage. Thus, we can conclude its above-average ROE is generated from its capacity to increase profit without a large debt burden.

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. General Dynamics’s above-industry ROE is encouraging, and is also in excess of its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. Although ROE can be a useful metric, it is only a small part of diligent research.

For General Dynamics, there are three key factors you should further examine:

1. Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Valuation: What is General Dynamics worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether General Dynamics is currently mispriced by the market.
3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of General Dynamics? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.