Do Its Financials Have Any Role To Play In Driving General Dynamics Corporation's (NYSE:GD) Stock Up Recently?

General Dynamics (NYSE:GD) has had a great run on the share market with its stock up by a significant 10% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on General Dynamics' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for General Dynamics

How Do You Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for General Dynamics is:

16% = US$3.4b ÷ US$21b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.16 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

General Dynamics' Earnings Growth And 16% ROE

To start with, General Dynamics' ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. Despite this, General Dynamics' five year net income growth was quite flat over the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

We then compared General Dynamics' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 6.6% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is GD fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is General Dynamics Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 41% (meaning the company retains59% of profits) in the last three-year period, General Dynamics' earnings growth was more or les flat. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, General Dynamics has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 36% of its profits over the next three years. Still, forecasts suggest that General Dynamics' future ROE will rise to 19% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we do feel that General Dynamics has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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This article by Simply Wall St 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. Simply Wall St has no position in any stocks mentioned.