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.
Table1: Key parameters of Titan Industries, Bata India and Solar Industries (Rs million)
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.
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
Source: ACE Equity
||Share Price Growth
||Growth in Nifty50
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.
More Views on News
Jun 10, 2017
Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.
Aug 21, 2017
Most Indians who cannot find jobs, look at becoming self-employed.
Aug 21, 2017
PersonalFN explains the chief factor pushing gold prices up of late.
Aug 21, 2017
One of the hallmarks of successful investing is to look out for companies that have a unique and enduring moat.
Aug 19, 2017
Ever heard of Lindy Effect? Find out how you can use it to pick timeless stocks.
More Views on News
Aug 10, 2017
Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.
Aug 8, 2017
'Yes, it looks like a bubble. And, yes, it's like buying a lottery ticket. But there's something happening that has never happened before. It's an evolutionary leap in money itself.'
Aug 8, 2017
Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...
Aug 12, 2017
The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.
Aug 10, 2017
Bitcoin hits an all-time high, is there more upside left?
Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement. LEGAL DISCLAIMER:
Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here
. The performance data quoted represents past performance and does not guarantee future results.SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.
Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: firstname.lastname@example.org. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407