General Dynamics Corporation's (NYSE:GD) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

General Dynamics (NYSE:GD) has had a rough three months with its share price down 12%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study General Dynamics' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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:

18% = US$3.4b ÷ US$19b (Based on the trailing twelve months to December 2022).

The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.18 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of General Dynamics' Earnings Growth And 18% ROE

To start with, General Dynamics' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 10%. Given the circumstances, we can't help but wonder why General Dynamics saw little to no growth in 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. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared General Dynamics' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 4.9% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 40% (implying that the company keeps 60% of its income) over the last three years, General Dynamics has seen a negligible amount of growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, General Dynamics has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 38%. Accordingly, forecasts suggest that General Dynamics' future ROE will be 20% which is again, similar to the current ROE.

Conclusion

In total, it does look like General Dynamics has some positive aspects to its business. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

What are the risks and opportunities for General Dynamics?

NYSE:GD

General Dynamics

General Dynamics Corporation operates as an aerospace and defense company worldwide.Show more

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Rewards

• Trading at 29.3% below our estimate of its fair value

• Earnings are forecast to grow 7.83% per year

• Earnings grew by 4.1% over the past year

Risks

• Has a high level of debt

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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.