Most readers would already know that General Dynamics' (NYSE:GD) stock increased by 4.2% over the past month. 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. Particularly, we will be paying attention to General Dynamics' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Do You Calculate Return On Equity?
Return on equity 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:
21% = US$3.3b ÷ US$15b (Based on the trailing twelve months to July 2021).
The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.21.
What Has ROE Got To Do With 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. 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.
General Dynamics' Earnings Growth And 21% ROE
At first glance, General Dynamics seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 7.9%. However, for some reason, the higher returns aren't reflected in General Dynamics' meagre five year net income growth average of 4.0%. That's a bit unexpected from a company which has such a high rate of return. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
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 19% in the same 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). Doing so will help them establish if the stock's future looks promising or ominous. 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 Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 35% (implying that the company retains the remaining 65% of its income), General Dynamics' earnings growth was quite low. 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 41% of its profits over the next three years. As a result, General Dynamics' ROE is not expected to change by much either, which we inferred from the analyst estimate of 21% for future ROE.
On the whole, we do feel that General Dynamics has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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