Lockheed Martin Corporation (NYSE:LMT) provided better ROE than its industry
One of the best investments we can make is in our own knowledge and skills. With that in mind, this article will explain how we can use return on equity (ROE) to better understand a business. We’ll use ROE to look at Lockheed Martin Corporation (NYSE:LMT), as a real-world example.
Return on equity or ROE is an important factor for a shareholder to consider as it tells them how much of their capital is being reinvested. In simpler terms, it measures a company’s profitability relative to equity.
See our latest analysis for Lockheed Martin
How to calculate return on equity?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the formula above, the ROE for Lockheed Martin is:
62% = US$6.2 billion ÷ US$10 billion (based on trailing 12 months to March 2022).
“Yield” refers to a company’s earnings over the past year. One way to conceptualize this is that for every $1 of share capital it has, the firm has made a profit of $0.62.
Does Lockheed Martin have a good ROE?
Perhaps the easiest way to assess a company’s ROE is to compare it to the industry average. However, this method is only useful as a rough check, as companies differ quite a bit within the same industry classification. As you can see in the graph below, Lockheed Martin has an above average ROE (10%) for the Aerospace and Defense industry.
That’s what we like to see. However, keep in mind that a high ROE does not necessarily indicate efficient profit generation. In addition to changes in net income, a high ROE can also be the result of high debt to equity, which indicates risk. You can see the 2 risks we have identified for Lockheed Martin by visiting our risk dashboard for free on our platform here.
The Importance of Debt to Return on Equity
Virtually all businesses need money to invest in the business, to increase their profits. The money for the investment can come from the previous year’s earnings (retained earnings), from issuing new shares or from borrowing. In the first two cases, the ROE will capture this use of capital to grow. In the latter case, debt used for growth will improve returns, but will not affect total equity. Thus, the use of debt can improve ROE, but with an additional risk in the event of a storm, metaphorically speaking.
Lockheed Martin’s debt and its ROE of 62%
Lockheed Martin uses a high amount of debt to increase returns. Its debt to equity ratio is 1.16. Its ROE is quite impressive, but it probably would have been lower without the use of debt. Investors need to think carefully about how a company would perform if it weren’t able to borrow so easily, as credit markets change over time.
Return on equity is a way to compare the business quality of different companies. In our books, the highest quality companies have a high return on equity, despite low leverage. If two companies have the same ROE, I would generally prefer the one with less debt.
But when a company is of high quality, the market often gives it a price that reflects that. The rate at which earnings are likely to grow, relative to earnings growth expectations reflected in the current price, should also be considered. You might want to check out this FREE analyst forecast visualization for the company.
But note: Lockheed Martin may not be the best stock to buy. So take a look at this free list of interesting companies with high ROE and low debt.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.