Avio S.p.A.'s (BIT:AVIO) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Avio (BIT:AVIO) has had a great run on the share market with its stock up by a significant 23% over the last three months. 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. Particularly, we will be paying attention to Avio's ROE today.

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.

We've discovered 2 warning signs about Avio. View them for free.

How To Calculate Return On Equity?

ROE 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 Avio is:

2.0% = €6.4m ÷ €313m (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. That means that for every €1 worth of shareholders' equity, the company generated €0.02 in profit.

View our latest analysis for Avio

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Avio's Earnings Growth And 2.0% ROE

As you can see, Avio's ROE looks pretty weak. Even when compared to the industry average of 11%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 37% seen by Avio 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. Such as - low earnings retention or poor allocation of capital.

However, when we compared Avio's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 21% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Avio is trading on a high P/E or a low P/E, relative to its industry.

Is Avio Using Its Retained Earnings Effectively?

Avio's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 92% (or a retention ratio of 8.1%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 2 risks we have identified for Avio visit our risks dashboard for free.

Additionally, Avio has paid dividends over a period of seven years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 49% over the next three years. The fact that the company's ROE is expected to rise to 7.0% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, Avio's performance is quite a big let-down. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.