BAE Systems plc's (LON:BA.) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

BAE Systems (LON:BA.) has had a rough three months with its share price down 17%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study BAE Systems' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

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How Is ROE Calculated?

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 BAE Systems is:

19% = UK£2.1b ÷ UK£11b (Based on the trailing twelve months to June 2025).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.19 in profit.

View our latest analysis for BAE Systems

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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of BAE Systems' Earnings Growth And 19% ROE

To start with, BAE Systems' ROE looks acceptable. Especially when compared to the industry average of 15% the company's ROE looks pretty impressive. This probably laid the ground for BAE Systems' moderate 7.8% net income growth seen over the past five years.

We then compared BAE Systems' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 53% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 51% (or a retention ratio of 49%) for BAE Systems suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Additionally, BAE Systems has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 47%. Accordingly, forecasts suggest that BAE Systems' future ROE will be 19% which is again, similar to the current ROE.

Conclusion

In total, it does look like BAE Systems has some positive aspects to its business. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.