To Keep Reading
NetEase Inc (NASDAQ: NTES) is a leading technology company in China. It provides premium online services focusing on gaming, music, and e-commerce.
Over the last decade, the company’s stock price has grown more than tenfold. Such strong returns naturally attract long-term investors (like myself) to learn more about the company.
In particular, I want to know one important aspect of the company – Does it have a high-quality business?
This question is important. If NetEase has a high-quality business, investors might consider this company for their own portfolio.
Here, I’ll use a simple metric to help us answer this question: The return on invested capital (ROIC).
A brief introduction to ROIC
In a previous article, I had explained how to use the return on invested capital (ROIC) to evaluate the quality of a business. For convenience’s sake, the math needed to calculate ROIC is given below.
Generally speaking, a high ROIC will mean a high-quality business while a low ROIC will point to a business of low quality. This is important for investors as a stock’s performance is often tied to the performance of its underlying business over the long term.
The simple idea behind the ROIC is that a business with a higher ROIC requires less capital to generate a profit, and it thus gives investors a higher return per dollar that is invested in the business.
Here’s a table showing NetEase’s ROIC (I have used numbers from its fiscal year ended 31 December 2018).
Source: NetEase’s Financial Results
In its fiscal year ended 31 December 2018 (FY2018), it generated an ROIC of -272.4%. This negative figure is unusual since NetEase has a negative capital employed of RMB 2.9 billion (US$415.6 million). What it means is that the company is using other people’s money (such as suppliers) to invest in its business.
Another thing to note here is that NetEase has a short-term loan of RMB 13.7 billion, which was not included in the above calculation. Personally, it would be useful to adjust this figure to give us a better representation of the capital requirement of this business.
Thus, after adjusting for the short-term loan, I arrive at an ROIC of 73.1% [7.9/(-2.9+13.7)]. This number is above average, based on the ROICs of many other companies I have studied in the past. This suggests that NetEase does indeed have a high-quality business.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Lawrence Nga doesn’t own shares in any companies mentioned.