It is hard to get excited after looking at Xiaomi's $XIAOMI-W(01810)$ recent performance, when its stock has declined 29% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Xiaomi's ROE.
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.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Xiaomi is:
22% = CN¥30b ÷ CN¥136b (Based on the trailing twelve months to June 2021).
The 'return' refers to a company's earnings over the last year. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.22.
What Has ROE Got To Do With 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 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.
Xiaomi's Earnings Growth And 22% ROE
To begin with, Xiaomi has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 8.4% also doesn't go unnoticed by us. As a result, Xiaomi's exceptional 67% net income growth seen over the past five years, doesn't come as a surprise.
As a next step, we compared Xiaomi'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 35%.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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await.
Is Xiaomi Efficiently Re-investing Its Profits?
Xiaomi doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.
Conclusion
On the whole, we feel that Xiaomi's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth.
Source:SIMPLYWALLST
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