Avi-Tech Holdings Limited's (SGX:1R6) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Avi-Tech Holdings' (SGX:1R6) stock is up by a considerable 13% over the past month. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. In this article, we decided to focus on Avi-Tech Holdings' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Avi-Tech Holdings

How Do You Calculate Return On Equity?

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 Avi-Tech Holdings is:

6.2% = S$3.2m ÷ S$52m (Based on the trailing twelve months to December 2022).

The 'return' refers to a company's earnings over the last year. So, this means that for every SGD1 of its shareholder's investments, the company generates a profit of SGD0.06.

What Is The Relationship Between ROE And 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 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.

Avi-Tech Holdings' Earnings Growth And 6.2% ROE

On the face of it, Avi-Tech Holdings' ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 24%. Given the circumstances, the significant decline in net income by 10% seen by Avi-Tech Holdings over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

That being said, we compared Avi-Tech Holdings' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 28% in the same 5-year period.

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. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Avi-Tech Holdings is trading on a high P/E or a low P/E, relative to its industry.

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

With a high three-year median payout ratio of 71% (implying that 29% of the profits are retained), most of Avi-Tech Holdings' profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 4 risks we have identified for Avi-Tech Holdings by visiting our risks dashboard for free on our platform here.

Additionally, Avi-Tech Holdings has paid dividends over a period of eight years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

Overall, we would be extremely cautious before making any decision on Avi-Tech Holdings. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of Avi-Tech Holdings' past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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