Xiaomi (HKG:1810) has had a great run on the share market with its stock up by a significant 77% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Xiaomi's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 Xiaomi

How Do You 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 Xiaomi is:

11% = CN¥19b ÷ CN¥178b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.11 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

A Side By Side comparison of Xiaomi's Earnings Growth And 11% ROE

To start with, Xiaomi's ROE looks acceptable. On comparing with the average industry ROE of 8.7% the company's ROE looks pretty remarkable. Given the circumstances, we can't help but wonder why Xiaomi saw little to no growth in the past five years. Therefore, there could be some other aspects that could potentially be preventing the company from growing. These include low earnings retention or poor allocation of capital.

Given that the industry shrunk its earnings at a rate of 5.5% over the last few years, the net income growth of the company is quite impressive.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is 1810 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Xiaomi Using Its Retained Earnings Effectively?

Xiaomi doesn't pay any regular dividends, meaning that the company is keeping all of its profits, which makes us wonder why it is retaining its earnings if it can't use them to grow its business. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Conclusion

On the whole, we feel that Xiaomi's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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.