Are Poor Financial Prospects Dragging Down Raytheon Technologies Corporation (NYSE:RTX Stock?
With its stock down 5.8% over the past month, it is easy to disregard Raytheon Technologies (NYSE:RTX). To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study Raytheon Technologies' ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Raytheon Technologies
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 Raytheon Technologies is:
7.2% = US$5.3b ÷ US$74b (Based on the trailing twelve months to December 2022).
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 $0.07.
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.
A Side By Side comparison of Raytheon Technologies' Earnings Growth And 7.2% ROE
When you first look at it, Raytheon Technologies' ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 10% either. Given the circumstances, the significant decline in net income by 5.5% seen by Raytheon Technologies over the last five years is not surprising. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
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 7.7% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is RTX fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Raytheon Technologies Using Its Retained Earnings Effectively?
With a high three-year median payout ratio of 70% (implying that 30% of the profits are retained), most of Raytheon Technologies' profits are being paid to shareholders, which explains the company's shrinking earnings. 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.
Additionally, Raytheon Technologies 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 39% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 13%, over the same period.
On the whole, Raytheon Technologies' performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.
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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.
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