Air Asia Co., Ltd.'s (TWSE:2630) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

Air Asia's (TWSE:2630) stock is up by a considerable 37% over the past month. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Air Asia's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Air Asia

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 Air Asia is:

1.7% = NT$57m ÷ NT$3.4b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.02 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Air Asia's Earnings Growth And 1.7% ROE

As you can see, Air Asia's ROE looks pretty weak. Even compared to the average industry ROE of 11%, the company's ROE is quite dismal. For this reason, Air Asia's five year net income decline of 13% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

As a next step, we compared Air Asia's performance with the industry and found thatAir Asia's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 6.9% in the same period, which is a slower than the company.

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. Is Air Asia fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Air Asia Efficiently Re-investing Its Profits?

Air Asia has a high three-year median payout ratio of 95% (that is, it is retaining 5.1% 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. To know the 2 risks we have identified for Air Asia visit our risks dashboard for free.

Additionally, Air Asia 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.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Air Asia. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. So far, we've only made a quick discussion around the company's earnings growth. So it may be worth checking this free detailed graph of Air Asia's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.