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Baidu (NASDAQ:BIDU) has had a great run on the share market with its stock up by a significant 11% over the last three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Baidu's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Baidu is:
8.5% = CN¥24b ÷ CN¥284b (Based on the trailing twelve months to December 2024).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.09 in profit.
Check out our latest analysis for Baidu
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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
A Side By Side comparison of Baidu's Earnings Growth And 8.5% ROE
On the face of it, Baidu's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.7%. Having said that, Baidu has shown a modest net income growth of 6.8% over the past five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
Next, on comparing with the industry net income growth, we found that Baidu's reported growth was lower than the industry growth of 19% over the last few years, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Baidu fairly valued compared to other companies? These 3 valuation measures might help you decide.