NetEase (NASDAQ:NTES) has had a rough three months with its share price down 11%. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to NetEase's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for NetEase

How Is ROE Calculated?

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 NetEase is:

17% = CN¥18b ÷ CN¥105b (Based on the trailing twelve months to June 2022).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.17 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

A Side By Side comparison of NetEase's Earnings Growth And 17% ROE

At first glance, NetEase seems to have a decent ROE. On comparing with the average industry ROE of 8.4% the company's ROE looks pretty remarkable. This certainly adds some context to NetEase's decent 11% net income growth seen over the past five years.

As a next step, we compared NetEase's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 26% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if NetEase is trading on a high P/E or a low P/E, relative to its industry.

Is NetEase Making Efficient Use Of Its Profits?

NetEase has a healthy combination of a moderate three-year median payout ratio of 30% (or a retention ratio of 70%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Additionally, NetEase has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 21% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Conclusion

Overall, we are quite pleased with NetEase's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.