X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Return on Capital Employed and share price: Part II - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • Oct 8, 2012

    Return on Capital Employed and share price: Part II

    In our first article we noted that if there was an increasing trend in RoCE for a particular company over a long period, the stock price also exhibited an increasing trend during that period.

    This article focuses on exploring whether the stock market punishes companies by pulling down their share prices if they continue to exhibit declining RoCEs' over the years.

    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. In the same vein, a company which exhibits a declining trend in RoCE over the years should encourage investors to withdraw their investments, resulting in a fall in the share price of the company.

    Three companies with decreasing RoCE trends from different sectors:

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

    The companies that we selected are Unitech Ltd, Videocon Industries Ltd and Career Point Ltd.

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

    Unitech Ltd: Unitech Ltd is a real estate developer engaged in residential, commercial, retail and hospitality projects. It also entered into a telecom joint-venture with Norway's Telenor to make inroads into the telecom sector in India. As of October 4, 2012, Unitech's market cap stood at Rs 68bn.

    Videocon Industries Ltd: Videocon Industries is engaged in the manufacturing of electronics and consumer durable items such as televisions and refrigerators. It also has stakes in oil fields in Africa and South America. As of October 4, 2012, its market cap stood at Rs 57bn.

    Career Point Ltd: Career Point is an education company headquartered at Kota, Rajasthan. It is in the businesses of tutorial services, education consultancy and management services, assessment and online testing services and infrastructure support services to educational institutions. As of October 4, 2012, its market cap stood at Rs 3bn.

    Table 1: Key parameters for Unitech, Videocon and Career Point for the period FY07 to FY12
    UNITECH LTD
      Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 CAGR(07-12)
    Gross Sales 32951 41195 28936 29316 34014 24296 -5%
    PBIT 19569 23848 20311 11224 10171 4944 -20%
    Capital Employed 76113 140659 160174 182035 176336 169876 14%
    ROCE 43% 22% 14% 7% 6% 3%  
    PBIT Margin 59% 58% 70% 38% 30% 20%  
    VIDEOCON INDUSTRIES LTD
      Sep-06 Sep-07 Sep-08 Sep-09 Dec-10 Dec-11 CAGR(06-11)
    Gross Sales 129634 125971 122371 106737 150287 136845 1%
    PBIT 12464 14196 17198 13860 11927 4513 -16%
    Capital Employed 118273 140259 190172 194517 232897 351072 20%
    ROCE 13% 11% 10% 7% 6% 2%  
    PBIT Margin 10% 11% 14% 13% 8% 3%  
    CAREER POINT LTD
      Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 CAGR(07-12)
    Gross Sales 291 380 452 617 786 796 18%
    PBIT 181 233 237 274 351 426 15%
    Capital Employed 253 421 623 1326 2656 2954 51%
    ROCE 72% 69% 45% 28% 18% 15%  
    PBIT Margin 62% 61% 53% 44% 45% 54%  
    Note: Videocon followed a September year end between 2006 and 2009 and a calendar year from 2010 onwards.
    Source: Ace Equity

    We observe from the above table that gross sales showed a steady declining trend at a compounded annual growth rate (CAGR) of 5% for Unitech Ltd between March07 and March12; given the high level of fixed operating cost, the Profit Before Interest and Tax (PBIT) fell disproportionately at a CAGR of 20% during the same period.

    Videocon Industries confronted a similar situation and witnessed growth in gross sales at a 1% CAGR between September06 and December11, while its PBIT fell at a CAGR of 16% during the same period.

    Career Point presented a completely different picture vis-c-vis Unitech and Videocon in the sense that its gross sales and PBIT increased at a CAGR of 18% and 15% respectively between March07 and March 12. And although its PBIT margin fell by 8%, it remained well above the 50% mark, which can be considered quite healthy.

    The commonality across the three companies is the disproportionate increase in Capital Employed (CE) as compared to the growth of gross sales and PBIT. While Career Point invested substantially in its business at a CAGR of 51% during FY07 and FY12, Unitech's and Videocon's CEs' increased at a CAGR of 14% and 20% respectively during our period of study.

    In our first article, we noted that in the case of Titan Industries, Bata India and Solar Industries, the increase in PBIT was at a faster pace than the increase in CE, which in turn resulted in higher RoCE's for each of them.

    However, in this article, Unitech, Videocon and Career Point present a polar opposite picture as their CEs' increased at a faster pace compared to their PBITs'. That in turn resulted in the drastic deterioration of their corresponding RoCEs' from 43%, 13% and 72% respectively at the beginning of our study period, to 3%, 2% and 15% respectively at the end of our study period.

    Share price performances of Unitech, Videocon Industries and Career Point:

    The following table presents the FY07 to FY12 period end share prices for Unitech, Videocon and Career Point.

    Table2: Share price performances of Unitech, Videocon and Career Point from FY07 to FY12
      Share Prices Share Price Growth Growth in Nifty50
      FY07 FY08 FY09 FY10 FY11 FY12 FY07-FY12 FY07-FY12
    Unitech 193.7 276.2 34.9 73.6 40.4 28.8 -85% 38%
    Videocon 407.8 370.6 195.4 251.2 216.7 174.4 -57%
    Career Point NA NA NA 470.5 331.1 194.6 -59%
    Source: Ace Equity

    Note: Between 2006 and 2009, September end prices are shown for Videocon and from 2010 onwards its share prices are as of December end. Career Point's FY10 share price is as of 29/10/2010 when it got listed and from FY11 onwards its share prices are as of March end. Growth in Nifty is from March 2007 to March2012.

    The above table clearly shows the abysmal share price declines of 85%, 57% and 59% for Unitech, Videocon and Career Point respectively vis-c-vis a 38% growth in Nifty50 between FY07 and FY12.

    Conclusion:

    Our analysis clearly reveals that an investor loses money by investing in the shares of companies with a declining RoCE trend. In fact, even if a company maintains a superior PBIT margin, and continues to grow its sales and PBIT as seen in the case of Career Point, its share price takes a beating in the long run, if the growth in investment (CE) outpaces the growth in PBIT.

    Thus, investors can certainly make valuable inferences from RoCE trends with regard to share prices of companies.

    However, as indicated in our first article on this topic, RoCE is just one of the parameters that an investor should keep in mind while picking stocks. Due consideration should be given to other valuation metrics like the Price to Earnings (P/E) ratio and the Enterprise Value to Earnings before interest, tax, depreciation and amortization (EV/EBITDA) ratio on trailing and prospective bases along with the company's ability to service its debt ( interest and principal) in the future.

     

     

    Equitymaster requests your view! Post a comment on "Return on Capital Employed and share price: Part II". Click here!

      
     

    More Views on News

    Tejas Networks Ltd. (IPO)

    Jun 14, 2017

    Should you subscribe to the IPO of Tejas Networks Ltd?

    Discover the Secrets of Hidden Smallcaps From These AGMs (The 5 Minute Wrapup)

    May 26, 2017

    Don't be surprised to come across some Super Investors there!

    A Trader's Nightmare. A Business Owner's Delight. (The 5 Minute Wrapup)

    May 19, 2017

    Not all small-cap investors see themselves as traders. Some see themselves as business owners.

    Securities & Intelligence Services Ltd. (IPO)

    Jul 31, 2017

    Should you subscribe to the IPO of Securities & Intelligence Services Ltd?

    Why Super Investors are Underperforming in This Market (The 5 Minute Wrapup)

    Jul 8, 2017

    If Super Investors can wait for the right pitch, so can you.

    More Views on News

    Most Popular

    Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

    Aug 7, 2017

    The data tells us quite a different story from the one the government is trying to project.

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

    Aug 7, 2017

    Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

    More
    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: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407
     

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms

    MARKET STATS