Alibaba Group Holding Limited (NYSE:BABA) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Most readers would already be aware that Alibaba Group Holding's (NYSE:BABA) stock increased significantly by 14% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Alibaba Group Holding's ROE today.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Alibaba Group Holding

How To 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 Alibaba Group Holding is:

5.9% = CN¥62b ÷ CN¥1.1t (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.06 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Alibaba Group Holding's Earnings Growth And 5.9% ROE

At first glance, Alibaba Group Holding's ROE doesn't look very promising. Next, when compared to the average industry ROE of 21%, the company's ROE leaves us feeling even less enthusiastic. For this reason, Alibaba Group Holding's five year net income decline of 18% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.

That being said, we compared Alibaba Group Holding's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 15% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. What is BABA worth today? The intrinsic value infographic in our free research report helps visualize whether BABA is currently mispriced by the market.

Is Alibaba Group Holding Making Efficient Use Of Its Profits?

Alibaba Group Holding's low three-year median payout ratio of 22% (implying that it retains the remaining 78% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

Only recently, Alibaba Group Holding stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 12% over the next three years. As a result, the expected drop in Alibaba Group Holding's payout ratio explains the anticipated rise in the company's future ROE to 10%, over the same period.

Conclusion

On the whole, we feel that the performance shown by Alibaba Group Holding can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.