Is BAE Systems plc's (LON:BA.) Recent Stock Performance Tethered To Its Strong Fundamentals?

BAE Systems (LON:BA.) has had a great run on the share market with its stock up by a significant 22% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study BAE Systems' ROE in this article.

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.

Check out our latest analysis for BAE Systems

How Do You 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 BAE Systems is:

18% = UK£1.9b ÷ UK£11b (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. 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?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

BAE Systems' Earnings Growth And 18% ROE

To start with, BAE Systems' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 10%. Probably as a result of this, BAE Systems was able to see a decent growth of 9.2% over the last five years.

We then performed a comparison between BAE Systems' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 11% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for BA.? You can find out in our latest intrinsic value infographic research report.

Is BAE Systems Making Efficient Use Of Its Profits?

BAE Systems has a healthy combination of a moderate three-year median payout ratio of 49% (or a retention ratio of 51%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Moreover, BAE Systems is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 46% of its profits over the next three years. As a result, BAE Systems' ROE is not expected to change by much either, which we inferred from the analyst estimate of 19% for future ROE.

Conclusion

In total, we are pretty happy with BAE Systems' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.