Is NetDragon Websoft Holdings Limited's(HKG:777) Recent Stock Performance Tethered To Its Strong Fundamentals?

NetDragon Websoft Holdings (HKG:777) has had a great run on the share market with its stock up by a significant 13% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on NetDragon Websoft Holdings' ROE.

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.

See our latest analysis for NetDragon Websoft Holdings

How To Calculate Return On Equity?

Return on equity 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:

9.7% = CN¥605m ÷ CN¥6.3b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every HK$1 of its shareholder's investments, the company generates a profit of HK$0.10.

What Is The Relationship Between ROE And 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 NetDragon Websoft Holdings' Earnings Growth And 9.7% ROE

To begin with, NetDragon Websoft Holdings seems to have a respectable ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 13%. However, we are pleased to see the impressive 69% net income growth reported by NetDragon Websoft Holdings over the past five years. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this certainly also provides some context to the high earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that NetDragon Websoft Holdings' growth is quite high when compared to the industry average growth of 32% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. What is 777 worth today? The intrinsic value infographic in our free research report helps visualize whether 777 is currently mispriced by the market.

Is NetDragon Websoft Holdings Efficiently Re-investing Its Profits?

NetDragon Websoft Holdings' ' three-year median payout ratio is on the lower side at 21% implying that it is retaining a higher percentage (79%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Moreover, NetDragon Websoft Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 21% of its profits over the next three years. Still, forecasts suggest that NetDragon Websoft Holdings' future ROE will rise to 15% even though the the company's payout ratio is not expected to change by much.

Conclusion

On the whole, we feel that NetDragon Websoft Holdings' performance has been quite good. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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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