It is hard to get excited after looking at Textron's (NYSE:TXT) recent performance, when its stock has declined 8.7% over the past three months. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Textron's ROE today.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Is ROE Calculated?

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 Textron is:

13% = US$932m ÷ US$6.9b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.13 in profit.

What Is The Relationship Between ROE And 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.

Textron's Earnings Growth And 13% ROE

To start with, Textron's ROE looks acceptable. Even when compared to the industry average of 14% the company's ROE looks quite decent. Despite the moderate return on equity, Textron has posted a net income growth of 2.6% over the past five years. A few likely reasons that could be keeping earnings growth low are - the company has a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared Textron's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 6.6% in the same period.

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). Doing so will help them establish if the stock's future looks promising or ominous. Is TXT fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Textron Using Its Retained Earnings Effectively?

A low three-year median payout ratio of 2.0% (implying that the company retains the remaining 98% of its income) suggests that Textron is retaining most of its profits. However, the low earnings growth number doesn't reflect this as high growth usually follows high profit retention. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Textron 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 1.4% over the next three years. As a result, the expected drop in Textron's payout ratio explains the anticipated rise in the company's future ROE to 17%, over the same period.

Summary

Overall, we feel that Textron certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.

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