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Wealth creators of the decade

Dec 16, 2011

In the longer run, creating wealth for its shareholders is the ultimate aim of any company. More often than not, wealth creation is deemed to be an increase in market capitalization of the company. However, it may be noted that shareholder value is created only if the company is able to earn a return that is higher than its cost of capital. And companies that create shareholder value effectively witness an increase in market capitalization over the longer run.

Now, let us dwell on the issue of shareholder value creation in detail to understand how it affects market prices of the companies. Let us assume that you are a shareholder of Bharti Airtel. While investing in the company, you have some minimum return expectations as your capital has opportunity cost attached to it. This is the cost of equity from the company's perspective. Apart from equity financing, the company may also borrow funds from debt holders. The interest rate on debt is referred to as cost of debt. After adjusting for the weights in capital structure, we arrive at the weighted average cost of capital (WACC) from the company's perspective.

Shareholder value, as measured by Economic Value Added (EVA), is simply the post tax operating profit earned by the firm after deducting the cost of financing (WACC - as explained above) Thus, simply put:-

EVA = Net operating profit less taxes - (Capital Employed*WACC)

Companies that consistently generate positive EVA create wealth for its shareholders. A company with a WACC higher than its return on capital effectively destroys wealth. In such cases, shareholders will be better off making investments in other companies.

Now that the concept of wealth creation is clear, let us take a look at the list of Sensex companies that have effectively created wealth for its shareholders over the last decade.

For our analysis, we have taken the average 10 years EBIT, tax rate and capital employed for all the Sensex companies under consideration. Although WACC is exclusive for every company, and varies according to the capital structure and cost of financing we have assumed a static figure of 13%. Considering the past period under study (low interest rates and risk premium) we believe that our assumption is justified to a certain extent.

However, please note that since we have assumed static WACC and standalone figures for comparison purposes, the outcome does not give a crystal clear/accurate picture with respect to wealth creation. Nonetheless, it does give a fair indication on companies which are on the right track of wealth creation.

Wealth Creators of the decade
Company Name* EBIT (Rs m) Tax Rate (%) NOPAT (Rs m) Capital Employed (Rs m) WACC (%) EVA (Rs m)
HDFC 63,753 22.1% 49,664 656,879 13% NA
HDFC Bank 80,231 31.1% 55,311 1,128,948 13% NA
ICICI Bank 197,136 11.6% 174,189 2,648,583 13% NA
SBI 464,441 36.2% 296,313 6,615,346 13% NA
ONGC 207,303 34.1% 136,633 713,573 13% 43,869
TCS^ 43,538 15.4% 36,829 96,127 13% 24,332
Infosys 40,728 15.7% 34,321 109,331 13% 20,108
HUL 22,372 19.4% 18,034 28,632 13% 14,312
ITC 39,509 31.5% 27,052 100,501 13% 13,986
Bharti Airtel 44,470 6.2% 41,730 213,482 13% 13,978
Wipro 29,176 13.3% 25,298 112,810 13% 10,633
BHEL 35,787 35.7% 23,011 99,564 13% 10,068
Coal India^ 30,552 4.5% 29,177 153,911 13% 9,168
Hero MotoCorp 14,989 29.6% 10,552 24,591 13% 7,356
L&T 28,347 26.5% 20,846 122,545 13% 4,916
Bajaj Auto 15,454 29.0% 10,972 46,712 13% 4,900
M&M 13,593 18.7% 11,054 59,509 13% 3,318
Maruti Suzuki 17,820 30.3% 12,429 74,484 13% 2,746
Sun Pharma 6,979 5.8% 6,575 34,030 13% 2,151
Tata Steel 59,932 29.5% 42,246 311,660 13% 1,730
Cipla 7,434 18.4% 6,066 33,586 13% 1,700
Jindal Steel & Power 13,086 20.5% 10,410 71,904 13% 1,062
Tata Motors 22,262 26.6% 16,331 146,474 13% (2,710)
Tata Power 11,554 17.4% 9,550 106,506 13% (4,296)
DLF 12,572 23.4% 9,630 109,573 13% (4,615)
JP Associates 13,741 30.2% 9,594 116,095 13% (5,498)
Sterlite Industries 9,161 11.2% 8,132 119,779 13% (7,439)
Hindalco 23,337 23.4% 17,883 198,369 13% (7,905)
NTPC 95,840 14.4% 82,049 723,164 13% (11,962)
Reliance Industries 152,727 18.5% 124,488 1,066,515 13% (14,159)
Source: Ace Equity & Company Annual reports, * Standalone Figures, ^ 8 years data

A cursory look at the table reveals that IT , Auto (Tata Motors an exception) and FMCG companies have been consistent wealth creators for over a decade. Contrary to expectations, even public sector undertakings like Bharat Heavy Electricals (BHEL) and Oil and Natural Gas Corporation Ltd. (ONGC) have been amongst wealth creators. In fact, ONGC has been the largest wealth creator in the entire universe. However, power and real estate companies have been a laggard here. Also, note that the concept of EVA is not strictly applicable to banking and housing finance stocks as they earn a spread on their borrowing rate and hence operating profit is not a true measure of their earnings potential. Thus, we have refrained from showing EVA calculations of these stocks.

Will the same stocks continue to rule the charts 10 years hence? We don't know for sure. The process of reversion to the mean is always at work in the market and hence, one should be on the lookout for companies that possess some durable competitive advantage.

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