General Dynamics Corporation's (NYSE:GD) Stock Has Shown A Decent Performance: Have Financials A Role To Play?

Most readers would already know that General Dynamics' (NYSE:GD) stock increased by 2.2% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for General Dynamics

How To Calculate Return On Equity?

The formula for return on equity is:

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

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

19% = US$3.3b ÷ US$17b (Based on the trailing twelve months to July 2022).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.19 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of General Dynamics' Earnings Growth And 19% ROE

To start with, General Dynamics' ROE looks acceptable. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. Despite this, General Dynamics' five year net income growth was quite low averaging at only 2.4%. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that General Dynamics' reported growth was lower than the industry growth of 5.7% in the same period, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. What is GD worth today? The intrinsic value infographic in our free research report helps visualize whether GD is currently mispriced by the market.

Is General Dynamics Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 40% (implying that the company retains the remaining 60% of its income), General Dynamics' earnings growth was quite low. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 39%. As a result, General Dynamics' ROE is not expected to change by much either, which we inferred from the analyst estimate of 20% for future ROE.

Summary

On the whole, we do feel that General Dynamics has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.