Dec 16, 2011|
Wealth creators of the decade
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.
EVA = Net operating profit less taxes - (Capital Employed*WACC)
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:-
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
Source: Ace Equity & Company Annual reports, * Standalone Figures, ^ 8 years data
||EBIT (Rs m)
||Tax Rate (%)
||NOPAT (Rs m)
||Capital Employed (Rs m)
||EVA (Rs m)
|Jindal Steel & Power
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.
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 18, 2017
Buying the index now will hardly help make money in stocks even in ten years.
Aug 18, 2017
Donald J Trump, a wrasslin' fan, took a 'Holy Sh*t!' blow on Tuesday.
Aug 17, 2017
PersonalFN simplifies the mutual fund account statement for you.
Aug 17, 2017
A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.
More Views on News
Aug 7, 2017
The data tells us quite a different story from the one the government is trying to project.
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
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 7, 2017
Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...
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: email@example.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407