With its stock down 11% over the past month, it is easy to disregard NetDragon Websoft Holdings (HKG:777). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company's financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study NetDragon Websoft Holdings' ROE in this article.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

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 NetDragon Websoft Holdings is:

7.2% = CN¥447m ÷ CN¥6.2b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.07 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

NetDragon Websoft Holdings' Earnings Growth And 7.2% ROE

On the face of it, NetDragon Websoft Holdings' ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 10%. As a result, NetDragon Websoft Holdings reported a very low income growth of 2.8% over the past five years.

As a next step, we compared NetDragon Websoft Holdings' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 19% in the same period.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about NetDragon Websoft Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is NetDragon Websoft Holdings Making Efficient Use Of Its Profits?

While NetDragon Websoft Holdings has a decent three-year median payout ratio of 34% (or a retention ratio of 66%), it has seen very little growth in earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, NetDragon Websoft Holdings 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 22% over the next three years. The fact that the company's ROE is expected to rise to 16% over the same period is explained by the drop in the payout ratio.

Conclusion

Overall, we have mixed feelings about NetDragon Websoft Holdings. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.

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