Avi-Tech Holdings Limited's (SGX:1R6) Dismal Stock Performance Reflects Weak Fundamentals

Avi-Tech Holdings (SGX:1R6) has had a rough three months with its share price down 10.0%. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study Avi-Tech Holdings' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Avi-Tech Holdings

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 Avi-Tech Holdings is:

6.1% = S$3.1m ÷ S$51m (Based on the trailing twelve months to June 2022).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every SGD1 worth of equity, the company was able to earn SGD0.06 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Avi-Tech Holdings' Earnings Growth And 6.1% ROE

On the face of it, Avi-Tech Holdings' ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 25% either. For this reason, Avi-Tech Holdings' five year net income decline of 11% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

However, when we compared Avi-Tech Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 29% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Avi-Tech Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Avi-Tech Holdings Efficiently Re-investing Its Profits?

Avi-Tech Holdings has a high three-year median payout ratio of 68% (that is, it is retaining 32% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 2 risks we have identified for Avi-Tech Holdings.

Moreover, Avi-Tech Holdings has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 100% over the next three years. Still, forecasts suggest that Avi-Tech Holdings' future ROE will rise to 11% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Conclusion

On the whole, Avi-Tech Holdings' performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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 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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