Raytheon Technologies (NYSE:RTX) has had a great run on the share market with its stock up by a significant 8.6% over the last month. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study Raytheon Technologies’ 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You Calculate Return On Equity?
ROE 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 Raytheon Technologies is:
3.2% = US$2.3b ÷ US$73b (Based on the trailing twelve months to June 2021).
The ‘return’ is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.03 in profit.
What Has ROE Got To Do With 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.
Raytheon Technologies’ Earnings Growth And 3.2% ROE
It is hard to argue that Raytheon Technologies’ ROE is much good in and of itself. Even compared to the average industry ROE of 13%, the company’s ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 35% seen by Raytheon Technologies was possibly a result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company’s earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.
So, as a next step, we compared Raytheon Technologies’ performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 14% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is RTX worth today? The intrinsic value infographic in our free research report helps visualize whether RTX is currently mispriced by the market.
Is Raytheon Technologies Making Efficient Use Of Its Profits?
Raytheon Technologies’ declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 50% (or a retention ratio of 50%). The business is only left with a small pool of capital to reinvest – A vicious cycle that doesn’t benefit the company in the long-run. Our risks dashboard should have the 3 risks we have identified for Raytheon Technologies.
In addition, Raytheon Technologies 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 is expected to drop to 36% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company’s ROE to 11%, over the same period.
Overall, we would be extremely cautious before making any decision on Raytheon Technologies. Because the company is not reinvesting much into the business, and given the low ROE, it’s not surprising to see the lack or absence of growth in its earnings. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company’s earnings growth rate. To know more about the company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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.
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