Neusoft's (SHSE:600718) stock is up by a considerable 35% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. Specifically, we decided to study Neusoft's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Do You 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 Neusoft is:

0.9% = CN¥83m ÷ CN¥9.6b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.01 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Neusoft's Earnings Growth And 0.9% ROE

It is quite clear that Neusoft's ROE is rather low. Even when compared to the industry average of 4.4%, the ROE figure is pretty disappointing. For this reason, Neusoft's five year net income decline of 6.6% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

However, when we compared Neusoft's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 1.0% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. 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. Is Neusoft fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Neusoft Efficiently Re-investing Its Profits?

Neusoft's very high three-year median payout ratio of 107% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Its usually very hard to sustain dividend payments that are higher than reported profits. To know the 2 risks we have identified for Neusoft visit our risks dashboard for free.

Moreover, Neusoft has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Conclusion

Overall, we would be extremely cautious before making any decision on Neusoft. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.