Xiaomi (HKG:1810) Will Want To Turn Around Its Return Trends

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Xiaomi (HKG:1810), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Xiaomi, this is the formula:

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

0.042 = CN¥8.2b ÷ (CN¥292b - CN¥95b) (Based on the trailing twelve months to June 2023).

Thus, Xiaomi has an ROCE of 4.2%. Even though it's in line with the industry average of 4.3%, it's still a low return by itself.

See our latest analysis for Xiaomi

In the above chart we have measured Xiaomi's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Xiaomi here for free.

What Can We Tell From Xiaomi's ROCE Trend?

On the surface, the trend of ROCE at Xiaomi doesn't inspire confidence. To be more specific, ROCE has fallen from 12% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Xiaomi has decreased its current liabilities to 32% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Xiaomi's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Xiaomi have fallen, meanwhile the business is employing more capital than it was five years ago. In spite of that, the stock has delivered a 24% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

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

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.