The Returns On Capital At Xiaomi (HKG:1810) Don't Inspire Confidence

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Xiaomi (HKG:1810) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Xiaomi is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.043 = CN¥8.0b ÷ (CN¥278b - CN¥94b) (Based on the trailing twelve months to September 2022).

Thus, Xiaomi has an ROCE of 4.3%. On its own, that's a low figure but it's around the 5.3% average generated by the Tech industry.

See our latest analysis for Xiaomi

Above you can see how the current ROCE for Xiaomi compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Xiaomi.

How Are Returns Trending?

When we looked at the ROCE trend at Xiaomi, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 4.3% from 12% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Xiaomi has decreased its current liabilities to 34% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

In summary, Xiaomi is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And with the stock having returned a mere 1.0% in the last three years to shareholders, you could argue that they're aware of these lackluster trends. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

One more thing to note, we've identified 2 warning signs with Xiaomi and understanding these should be part of your investment process.

While Xiaomi may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.