NetEase's (NASDAQ:NTES) stock is up by a considerable 22% over the past month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to NetEase'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for NetEase is:
15% = CN¥14b ÷ CN¥97b (Based on the trailing twelve months to September 2020).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.15 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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.
NetEase's Earnings Growth And 15% ROE
To begin with, NetEase seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 16%. This certainly adds some context to NetEase's moderate 10% net income growth seen over the past five years.
We then compared NetEase's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 41% in the same period, which is a bit concerning.
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). This then helps them determine if the stock is placed for a bright or bleak future. Is NTES fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is NetEase Using Its Retained Earnings Effectively?
NetEase's three-year median payout ratio to shareholders is 24% (implying that it retains 76% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.
Besides, NetEase has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 22% of its profits over the next three years. Accordingly, forecasts suggest that NetEase's future ROE will be 15% which is again, similar to the current ROE.
In total, we are pretty happy with NetEase's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.
This article by Simply Wall St is general in nature. 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.
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