Is the Market Following Fundamentals?

Northrop Grumman’s (NYSE:NOC) stock is up by a considerable 15% over the past three months. Given the company’s impressive performance, we decided to study its financial indicators more closely as a company’s financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Northrop Grumman’s ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.

Check out our latest analysis for Northrop Grumman

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 Northrop Grumman is:

40% = US$5.5b ÷ US$14b (Based on the trailing twelve months to September 2022).

The ‘return’ is the profit over the last twelve months. That means that for every $1 worth of shareholders’ equity, the company generated $0.40 in profit.

Why Is ROE Important For Earnings Growth?

So 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that do not share these attributes.

Northrop Grumman’s Earnings Growth And 40% ROE

To begin with, Northrop Grumman has a pretty high ROE which is interesting. Additionally, the company’s ROE is higher compared to the industry average of 10% which is quite remarkable. Probably as a result of this, Northrop Grumman was able to see a decent net income growth of 17% over the last five years.

As a next step, we compared Northrop Grumman’s net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 5.5%.

past-earnings-growth

past-earnings-growth

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). This then helps them determine if the stock is placed for a bright or bleak future. What is NOC worth today? The intrinsic value infographic in our free research report helps visualize whether NOC is currently mispriced by the market.

Is Northrop Grumman Efficiently Re-investing Its Profits?

Northrop Grumman has a low three-year median payout ratio of 21%, meaning that the company retains the remaining 79% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Moreover, Northrop Grumman 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’s future payout ratio is expected to rise to 30% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company’s expected ROE (to 26%) over the same period.

Conclusion

In total, we are pretty happy with Northrop Grumman’s performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company’s earnings growth is expected to slow down. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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 into account 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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