India Inc’s return on equity could be on the cusp of a turnaround

Return on Equity (RoE), a key metric to evaluate efficiency of capital allocation that had dipped to a 16-year low for BSE 500 companies, is likely to improve on several government initiatives, according to a report by Motilal Oswal Financial Services.

RoEs of corporate India — excluding public sector banks (PSBs), the telecom and automotive sectors — have already improved to 14 per cent in financial year 2019 from a decade low of 12.5 per cent in fiscal year 2015, the brokerage said.

“This improvement could gain further steam as PSBs begin reporting improved financials off a low base which was created due to the cleaning up of their balance sheets by providing for NPAs. The telecom sector gains strength led by easing competitive intensity and rising average revenue per user (ARPUs), while auto sector sluggishness eases out post-implementation of BS-VI norms,” it said.


“The corporate tax cut announced in FY20 is also going to boost the earnings and, hence, RoEs for most companies,” it added.

RoE has been largely impacted by provisioning for bad loans or write offs by public sector banks, intensifying competition in the telecom sector and shrinking margins in the auto sector, the report said.

Companies with improving RoE and earnings growth are the best for market cap creation, according to Motilal Oswal.

The analysis of BSE 500 companies over two phases from financial years 2008-2013 and from 2013-2019 has revealed that companies with both improving RoE and earnings are ideal for generating best returns, while those with declining RoE and earnings growth have delivered the weakest market cap returns.

Companies such as Axis Bank, Bharti Airtel, Hindustan Unilever, Infosys, Ultratech Cement, Federal Bank, JSW Energy, Tata Global, Trent and Voltas appear attractive based on the framework of improving RoEs and increase in net profit growth estimates for FY20-22, according to the Mumbai-based brokerage.

RoE of BSE 500 companies moved up from 16.8 per cent in FY03 to a high of 22.9 per cent in FY07, but trended down after the financial crisis of 2008 due to a slew of macro and microeconomic factors.

It stood at 9.5 per cent in FY19 – the lowest in the last 16 years.

Over the last 16 years, mid-caps have outperformed large-caps in market cap creation percentage-wise despite generally higher RoE of large-caps.

This, the brokerage said, was primarily due to much higher improvement in RoE of mid-caps and high earnings growth.

Earnings growth of mid-cap companies was almost two times that of large-cap companies over two phases (FY03-08 and FY08-13). However, over FY13-19, mid-cap profits declined at a compounded annual rate of 7 per cent mainly due to the loss-making PSBs which distorted the picture, as per the report.