Are Avertronics Inc.'s (GTSM:3597) Mixed Financials The Reason For Its Gloomy Performance on The Stock Market?

With its stock down 2.0% over the past month, it is easy to disregard Avertronics (GTSM:3597). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Avertronics' 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 Avertronics

How To Calculate Return On Equity?

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 Avertronics is:

8.6% = NT$40m ÷ NT$466m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every NT$1 worth of equity, the company was able to earn NT$0.09 in profit.

Why Is ROE Important For 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.

A Side By Side comparison of Avertronics' Earnings Growth And 8.6% ROE

At first glance, Avertronics' ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.9%. Having said that, Avertronics has shown a modest net income growth of 16% over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Avertronics' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 9.2% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Avertronics''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Avertronics Using Its Retained Earnings Effectively?

Avertronics has a significant three-year median payout ratio of 92%, meaning that it is left with only 8.2% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Moreover, Avertronics is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

Overall, we have mixed feelings about Avertronics. Although the company has shown a pretty impressive growth in earnings, yet the low ROE and the low rate of reinvestment makes us skeptical about the continuity of that growth, especially when or if the business comes to face any threats. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Avertronics' past profit growth, check out this visualization of past earnings, revenue and cash flows.

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This article by Simply Wall St is general in nature. 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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