Xiaomi (SEHK:1810) (NASDAQOTH:XIACF) (NASDAQOTH:XIACY), a Chinese vendor of low-cost smartphones, recently gave its third-quarter earnings report -- its second ever as a public company. Like most Chinese tech stocks, Xiaomi has sold off mightily this year due to the ongoing U.S.-China trade war. The stock went public in July.

Still, Xiaomi's recent earnings report continued its strong revenue growth story. Revenue was up 49% over the year-ago period. While the stock has risen since the company's earnings report, the price on it's Hong Kong-traded shares as of this writing of roughly HKD 14.60 is below the HKD 17 IPO price and even further below the 52-week high of HKD 22.20. Is now the time to buy? (The stock trades on U.S. exchanges under the tickers XIACF and XIACY.)

Close-up of a man's hand holding a smartphone

Image source: Getty Images.

Still a growth monster

Xiaomi continued its record of torrid revenue growth in the most recently reported quarter, with broad-based strength across the core mobile phone segment, Internet of Things (IoT) and lifestyle products, and internet services, across all geographies:

Segment

Q3 2018 Growth Rate

Percentage of Q3 Revenue

Mobile phones

36.1%

68.8%

IoT and lifestyle

89.8%

21.3%

Internet services

85.5%

9.3%

Other

125%

0.6%

Total

49.1%

100%

Data source: Xiaomi Q3 2017 investor presentation and release.

These are certainly impressive growth numbers, so why is the market so skeptical? Let's dig beneath the surface.

Phones, phones, and more types of phones

While Xiaomi likes to portray itself as an overall tech brand and not just a phone company, the market will likely emphasize the company's phone segment for the foreseeable future. Xiaomi still derives a majority of revenues from phones.

Xiaomi's low-priced strategy appears to be gaining fans: Phone shipments rose 21.2% year over year, in contrast with the global phone industry, which saw units fall an ugly 6%. As a result, Xiaomi saw its global shipment market share increase from 7.5% to 9.7%, good for fourth place.

Xiaomi's strength came not only in its home market of China, but also key overseas markets like India, where Xiaomi retained its No. 1 position (30% market share); Indonesia, where Xiaomi leapfrogged Oppo and Vivo to go from the No. 4 to the No. 2 position (23% share); and even Western Europe, where Xiaomi grew shipments 336%, increasing its market share from 1% to 4% -- good for fourth place.

Even better, Xiaomi's average selling price for phones increased 16% in China and 18% overseas, as it introduced higher-end smartphones. These included the Mi 8, which on the recent Singles Day holiday was the best-selling phone in the RMB 2,000 to RMB 3,000 range on Alibaba's Tmall and on JD.com.

Xiaomi is also pursuing a new multibrand strategy in order to segment its audience away from mere low-priced phones. For instance, Xiaomi released a specialized Poco brand, a superfast phone for tech enthusiasts, as well as the Black Shark model, designed specifically for mobile gamers.

It's an interesting turn for a big company with a well-known brand: After all, you don't see Apple releasing phones that aren't called iPhones. The strategy speaks to the variety of segments Xiaomi is trying to hit in its volume-based strategy across the globe.

IoT and lifestyle are taking off, too

From a much smaller base, Xiaomi is also steadily expanding its other categories. Smart TVs grew a whopping 199% year over year. The company also launched a new Mi air conditioner in July.

In internet services (mostly advertising and value-added service apps), Xiaomi reported a strong increase (43.4%) in monthly active users and average revenue per user increased by 29.4%. This bears watching, as internet services have the potential to drive Xiaomi's future margins, but the category still only makes up less than 10% of revenue.

About those margins...

Unfortunately for investors, the company's margin profile is going the opposite way of revenue growth. Gross margin shrank by 240 basis points from 15.3% to 13.9%, and adjusted net profit margin shrank from 7.2% last year to 5.7%.

The culprit was smartphone margin, which compressed all the way from 11.7% to 6.1%, which the company attributed to currency fluctuations. However, IoT and lifestyle expanded gross margin from 10.2% to 10.5%, and internet services grew gross margin from 61.2% to 68.4%. Still, these improvements were not enough to counteract the thinner margins in phones, which still dominate Xiaomi's mix for now.

Xiaomi is a unique growth story

Xiaomi remains a bit of a puzzle, since the vast majority of its revenue comes from low-margin phones. The company appears to be scaling impressively and gaining users, but robust earnings growth will likely occur only if the company can grow its internet services business, which is still just 9.3% of sales. That's the product segment to watch, and will likely determine the ultimate success of the stock.

Billy Duberstein owns shares of BABA, Apple, Xiaomi, and JD and has the following options: short January 2019 $30 puts on JD. The Motley Fool owns shares of and recommends Apple and JD. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.