Is The Market Rewarding Textron Inc. (NYSE:TXT) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?

It is hard to get excited after looking at Textron's (NYSE:TXT) recent performance, when its stock has declined 3.6% over the past month. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study Textron's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Textron

How Is ROE Calculated?

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 Textron is:

6.8% = US$377m ÷ US$5.5b (Based on the trailing twelve months to July 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.07 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Textron's Earnings Growth And 6.8% ROE

When you first look at it, Textron's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 11%, the company's ROE leaves us feeling even less enthusiastic. Accordingly, Textron's low net income growth of 3.1% over the past five years can possibly be explained by the low ROE amongst other factors.

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 17% in the same period.

Earnings growth is a huge factor in stock valuation. 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. Is Textron fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Textron Making Efficient Use Of Its Profits?

Textron's low three-year median payout ratio of 2.5% (or a retention ratio of 97%) should mean that the company is retaining most of its earnings to fuel its growth. However, the low earnings growth number doesn't reflect this as high growth usually follows high profit retention. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, Textron has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 2.3%. However, Textron's ROE is predicted to rise to 10% despite there being no anticipated change in its payout ratio.

Conclusion

Overall, we have mixed feelings about Textron. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

This article by Simply Wall St is general in nature. 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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