General Dynamics' (NYSE:GD) stock is up by a considerable 8.9% over the past week. 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

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How To Calculate Return On Equity?

The formula for ROE is:

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

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

17% = US$3.8b ÷ US$22b (Based on the trailing twelve months to December 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.17.

View our latest analysis for General Dynamics

Why Is ROE Important For 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 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 17% 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 12%. Despite this, General Dynamics' five year net income growth was quite flat over the past five years. Therefore, there could be some other aspects that could potentially be preventing the company from growing. These include 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 11% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for GD? You can find out in our latest intrinsic value infographic research report.

Is General Dynamics Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 41% (implying that the company keeps 59% 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.

Moreover, General Dynamics has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 37%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 20%.

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. 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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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.