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Return on Capital Employed and its linkage with share price performance - Views on News from Equitymaster
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  • Sep 27, 2012

    Return on Capital Employed and its linkage with share price performance

    This article focuses on exploring whether any positive correlation exists between Return on Capital Employed (RoCE) and share price growth trends.

    Return on Capital Employed (RoCE):

    RoCE is a measure of how effectively a company is able to deploy its capital base (debt and equity) to generate returns for the capital providers. A company which can generate higher return from a lower capital base and continues to improve on the same, should in theory, always be preferred over its peers which need higher capital to generate the same level of return and which cannot sustain the growth in RoCE. As a corollary, this superior RoCE performance should get reflected through the growth in share price.

    Three companies with increasing RoCE trends from different sectors:

    To test the above hypothesis, we analyze three companies from different sectors with dissimilar market capitalization and with increasing RoCE trends for the period FY07 to FY12.

    The companies that we selected are Titan Industries Ltd, Bata India Ltd and Solar Industries India Ltd

    A very brief description of each of the above companies is as follows:

    Titan Industries Ltd: Titan Industries is engaged in the manufacturing of quartz watches and other branded jewellery. As of September 26, 2012, its market cap stood at Rs 217 bn.

    Bata India Ltd: Bata India is one of the largest manufacturers and retailers of footwear in India. As of September 26, 2012, its market cap was Rs 60 bn.

    Solar Industries India Ltd: Solar Industries is India's largest manufacturer of industrial explosives and explosive initiating systems. As of September 26, 2012, the market cap of Solar Industries was Rs 17 bn.

    The following table presents some key parameters for each of the above companies between the period FY07 and FY12.

    Table1: Key parameters of Titan Industries, Bata India and Solar Industries (Rs million)
      FY07 FY08 FY09 FY10 FY11 FY12 CAGR(07-12)
    Gross Sales 21369 30466 38787 47069 65850 89831 27%
    PBIT 1706 2100 2669 3480 6378 8842 32%
    Capital Employed 5807 6561 7244 8049 10906 15376 18%
    ROCE 32.1% 34.0% 38.7% 45.5% 67.3% 67.3%  
    PBIT Margin 8.0% 6.9% 6.9% 7.4% 9.7% 9.8%  
      CY06 CY07 CY08 CY09 CY10 CY11 CAGR(06-11)
    Gross Sales 7948 8908 10131 11133 12947 15711 12%
    PBIT 471 560 809 1054 1438 3628 41%
    Capital Employed 2421 2698 2966 3282 4343 5623 15%
    ROCE(%) 19.5% 21.9% 28.5% 33.7% 37.7% 72.8%  
    PBIT Margin 5.9% 6.3% 8.0% 9.5% 11.1% 23.1%  
      FY07 FY08 FY09 FY10 FY11 FY12 CAGR(07-12)
    Gross Sales 2377 3210 5304 5902 7243 10317 28%
    PBIT 345 652 895 1039 1403 1775 31%
    Capital Employed 2558 2956 2898 3689 3902 5231 13%
    ROCE(%) 15.2% 23.7% 30.6% 31.5% 37.0% 38.9%  
    PBIT Margin 14.5% 20.3% 16.9% 17.6% 19.4% 17.2%  
    Note: Bata India follows a calendar year end
    Source: ACE Equity

    From the above table, it is evident that Gross Sales, Profit before Interest and Tax (PBIT), and Capital Employed (CE) have grown for all the three companies across the period FY07 to FY12.

    The compounded annual sales growth rate (CAGR) was 27% for Titan, 12% for Bata and 28% for Solar Industries. PBIT grew at a CAGR of 32%, 41% and 31% for Titan, Bata and Solar Industries respectively, while CE grew at a CAGR of 18%, 15% and 13% respectively for Titan, Bata and Solar Industries.

    So, for each of these companies, PBIT increased at a higher rate than CE, and as a result RoCE grew significantly from FY07 to FY12. In fact, as the table shows, RoCE for Titan more than doubled, for Bata India it nearly quadrupled and for Solar Industries it also got more than doubled. These RoCE trends thus clearly highlight efficient capital management by each of the companies.

    Share price performances of Titan Industries, Bata India and Solar Industries:

    The following table presents the share prices for Titan Industries, Bata India and Solar Industries as at the end of each accounting periods between FY07 and FY12.

    Table 2: Share price performances of Titan Industries, Bata India and Solar Industries
      Share Prices Share Price Growth Growth in Nifty50
      FY07 FY08 FY09 FY10 FY11 FY12 FY07-FY12 FY07-FY12
    Titan Industries 42.1 52.9 39.1 92.0 190.6 228.6 443% 38%
    Bata India 202.9 286.8 107.4 197.1 362.2 530.1 161%
    Solar Industries 113.5 421.0 212.1 431.5 583.3 839.3 639%
    Source: ACE Equity

    From the above table, we infer that if an investor invested an equal amount of money in the equity shares of Titan, Bata and Solar Industries at the end of FY07, and kept on holding those shares till the end of FY12, he would have earned a return of 443%, 161% and 639% on each of those investments, respectively.

    We also observe that the growth in share prices of these companies was significantly higher than that of the of Nifty 50 during the same 5 year period.


    Our analysis clearly demonstrates that a company with superior and consistent RoCE growth can reward its shareholders handsomely over the long run. Further the analysis also leads us to conclude that 'bottom-up' stock picking with a long term horizon can be more rewarding for shareholders rather than trying to time the market or investing blindly in an index, as was amply exemplified by the exceptional growth in share prices of Titan, Bata and Solar Industries vs. the Nifty50 between FY07 and FY12.

    We would like to remind investors that RoCE is just one of the parameters that an investor should keep in mind while picking stocks and although we wanted to determine whether the three sample companies created wealth specifically for the shareholders, we focused on RoCE rather than on Return on Equity (RoE) as we wanted to know the profitability associated with the respective business models of the sample companies, irrespective of their capital structures.

    RoEs' can be artificially inflated by taking resort to higher debt levels and often companies which rely on higher gearing (debt to equity ratio) tend to fare badly in cyclical downturns (The companies that we selected in our sample made a conscious effort to reduce their gearing on a year on year basis; however, we are not suggesting that an investor should always ignore companies with debt).

    Finally, an investor should also keep in mind other valuation metrics like the Price to Earning (P/E) ratio and the Enterprise Value to Earnings before Interest, Tax and Depreciation (EV/EBITDA) ratio on trailing and projected bases. While historical data may be readily available, projection of financial metrics is a combination of art and science and requires pain-staking research.



    Equitymaster requests your view! Post a comment on "Return on Capital Employed and its linkage with share price performance". Click here!

    6 Responses to "Return on Capital Employed and its linkage with share price performance"

    Anjan Kumar Chaudhuri

    Sep 26, 2013

    A well written article to ensure the investment as "safe and remunerative ",specially for the beginners.Expect more such articles from your end.



    Sep 1, 2013

    A very well written article.

    Like (1)

    Rajiv Juneja

    Nov 9, 2012

    Conclusion is really good and enlightening.

    Like (1)


    Oct 5, 2012

    Very short, crisp and enlightening article. However, would like a rejoinder in which if possible, these metrics have been violated and under what circumstances. That is, if there are examples wherein even with high current RoCE, the share price has not moved appropriately. Whether there are other non-numerical factors that influence long term performance of a company.

    Like (1)


    Oct 4, 2012

    Very good

    Like (1)

    v s p rao

    Oct 2, 2012

    The concept is well illustrated.

    Like (1)
    Equitymaster requests your view! Post a comment on "Return on Capital Employed and its linkage with share price performance". Click here!

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