India Inc’s return on equity (RoE) fell to 9.5% in FY19 – its lowest in 16 years – on the back of declining profitability and asset returns of companies.
India Inc’s return on equity (RoE) fell to 9.5% in FY19 – its lowest in 16 years – on the back of declining profitability and asset returns of companies. The ratio has more-than halved from the high of 22.9% seen in FY07, said Motilal Oswal, in a report. RoE shows how good a company is at generating returns from its investment. In India, sectors such as public sector banks (PSBs), metals, oil and gas as well as utilities contribute the most to the RoE of listed companies.
“ In the recent past, RoE has been largely impacted by high NPA provisioning/write offs made by PSBs, intensifying competition in the telecom sector and shrinking margins in the auto sector. However, excluding PSBs, telecom and auto, the ratio has shown signs of a recovery in recent years,” said Motilal Oswal. For FY19, sectors such as telecom, infrastructure and PSBs clocked negative RoE. Indian companies have been cyclical or have seen major ups and downs with respect to their RoE because of its dependency on companies which belong to the sectors that witness cyclical growth.
Additionally, RoE is also an effective method for investors to analyse how effective the capital allocation in a company is. The report suggested that cash rich companies can improve their RoE by increasing earnings payout, which, in turn, would uplift valuation multiple. After analysing BSE 200 companies, the brokerage concluded that a change in the market capitalization is directly impacted by the RoE of companies. “Companies delivering RoE improvement (at end v/s start of the respective period) have significantly outperformed those witnessing a decline in RoE. Companies with improving RoE have delivered aggregate market,” said the report.
The RoE of public sector units and private sector companies is on a par. But, while comparing RoE’s by market capitalization of companies, the brokerage arrived at a conclusion that in spite of low RoEs, midcaps have outperformed largecap companies in three different market cycles. It said: “Midcaps have lower RoEs than largecaps in all the three tested cycles. This is on account of higher earnings growth and thus, higher variability in RoEs of midcap.”
The brokerage further said that companies in the high-dividend-paying sectors such as consumer and technology were adversely impacted by the implementation of Ind-AS. The structural reform of demonetisation in FY17 and the rollout of GST in FY18 also led to some temporary hiccups in corporate earnings growth and RoE.