Xiaomi (HKG:1810) May Have Issues Allocating Its Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Xiaomi (HKG:1810) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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)

0.031 = CN¥5.8b ÷ (CN¥264b - CN¥76b) (Based on the trailing twelve months to March 2023).

Thus, Xiaomi has an ROCE of 3.1%. Even though it's in line with the industry average of 3.3%, it's still a low return by itself.

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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Xiaomi's ROCE Trend?

On the surface, the trend of ROCE at Xiaomi doesn't inspire confidence. Around five years ago the returns on capital were 12%, but since then they've fallen to 3.1%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Xiaomi has done well to pay down its current liabilities to 29% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Xiaomi's ROCE

In summary, we're somewhat concerned by Xiaomi's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 29% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you want to continue researching Xiaomi, you might be interested to know about the 1 warning sign that our analysis has discovered.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.