Carlo Gavazzi Holding AG's (VTX:GAV) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

editorial-team@simplywallst.com (Simply Wall St)

Sat, Oct 14, 2023, 12:47 AM 4 min read

Carlo Gavazzi Holding (VTX:GAV) has had a rough three months with its share price down 16%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Carlo Gavazzi Holding's ROE today.

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.

See our latest analysis for Carlo Gavazzi Holding

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 Carlo Gavazzi Holding is:

21% = CHF28m ÷ CHF132m (Based on the trailing twelve months to March 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CHF1 of shareholders' capital it has, the company made CHF0.21 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Carlo Gavazzi Holding's Earnings Growth And 21% ROE

Firstly, we acknowledge that Carlo Gavazzi Holding has a significantly high ROE. Even when compared to the industry average of 19% the company's ROE is pretty decent. Therefore, it might not be wrong to say that the impressive five year 29% net income growth seen by Carlo Gavazzi Holding was probably achieved as a result of the high ROE.

As a next step, we compared Carlo Gavazzi Holding's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 20%.

past-earnings-growth — SWX:GAV Past Earnings Growth October 14th 2023

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. Has the market priced in the future outlook for GAV? You can find out in our latest intrinsic value infographic research report.

Is Carlo Gavazzi Holding Making Efficient Use Of Its Profits?

Carlo Gavazzi Holding's three-year median payout ratio is a pretty moderate 39%, meaning the company retains 61% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Carlo Gavazzi Holding is reinvesting its earnings efficiently.

Moreover, Carlo Gavazzi Holding 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 41% of its profits over the next three years. Still, forecasts suggest that Carlo Gavazzi Holding's future ROE will drop to 13% even though the the company's payout ratio is not expected to change by much.

Conclusion

In total, we are pretty happy with Carlo Gavazzi Holding's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 2 risks we have identified for Carlo Gavazzi Holding by visiting our risks dashboard for free on our platform here.

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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.