Alibaba Group Holding Limited (NYSE:BABA) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Alibaba Group Holding's (NYSE:BABA) stock is up by a considerable 8.4% over the past week. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Alibaba Group Holding's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Alibaba Group Holding

How Is ROE Calculated?

Return on equity 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:

8.1% = CN¥92b ÷ CN¥1.1t (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.08 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Alibaba Group Holding's Earnings Growth And 8.1% ROE

At first glance, Alibaba Group Holding's ROE doesn't look very promising. Next, when compared to the average industry ROE of 15%, the company's ROE leaves us feeling even less enthusiastic. Given the circumstances, the significant decline in net income by 12% seen by Alibaba Group Holding over the last five years is not surprising. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

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 14% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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 Using Its Retained Earnings Effectively?

When we piece together Alibaba Group Holding's low three-year median payout ratio of 19% (where it is retaining 81% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.

Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 11% 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. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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.