How well have Indian companies deployed the earnings retained by them?
Earnings growth is a key factor to look for when evaluating any company as a potential investment. The ideal situation would be if a company is able to generate positive earnings through economic and business cycles and better still, be able to grow them over a reasonably long period of time. A key factor that enables a company to achieve this goal is the management’s ability to run its business efficiently. Investors typically assess management capability through a metric called the Return on Equity.
A company’s sources of funds are primarily debt (for example bank loans) and equity (capital contributed by owners / shareholders). The typical uses for these funds are – working capital requirements, capital expenditure (both to maintain existing operations as well as for new projects) and capital return (paying interest to creditors and paying dividends to shareholders). Ideally, if the management is not in a position to generate a return greater than the cost of funds on surplus capital, then it should return the excess capital back to the shareholders. Debt is a had different issue as it is contractual and has a predefined maturity period. It is in this context it becomes interesting to see the returns generated by listed companies in India on earnings they have retained in the company and not paid out to shareholders. It is important to analyse this issue using per share earnings to keep out the effect of capital dilution.
In this analysis, we look for companies listed on the National Stock Exchange that have generated positive earnings and also grew them year-on-year every single year during the period 2010-2019. Instead of measuring the management quality through a static ROE, we use an incremental measure, IROE. We can define the IROE (incremental ROE) as the return generated on earnings retained during a period of time (IROE = change in earnings during a period as a percentage of earnings retained during the same period).
The following table lists the results. We started out with 1998 companies listed on the NSE as of Nov 18, 2019 and filtered out companies where the cumulative change in earnings or retained earnings during 2010-2019 was not positive. We also removed companies which did not have data for the full period. We were left with 784 companies. Of these 784 companies, only 19 companies had positive earnings that increased year-on-year for every single year during 2010-2019.
| Company | Increase in EPS 2010-2019 | Cumulative earnings retained 2010-2019 | IROE |
| TATA CONSULTANCY SVCS LTD | 65.2 | 291.4 | 22.4% |
| HDFC BANK LIMITED | 34.4 | 172.7 | 19.9% |
| HOUSING DEVELOPMENT FINANCE | 72.7 | 394.5 | 18.4% |
| ASIAN PAINTS LTD | 13.8 | 88.3 | 15.6% |
| POWER GRID CORP OF INDIA LTD | 19.2 | 76.1 | 25.2% |
| DABUR INDIA LTD | 5.3 | 37.3 | 14.1% |
| BRITANNIA INDUSTRIES LTD | 43.9 | 158.8 | 27.6% |
| EICHER MOTORS LTD | 736.6 | 2865.6 | 25.7% |
| MARICO LTD | 6.8 | 24.7 | 27.5% |
| ABBOTT INDIA LTD | 156.9 | 867.3 | 18.1% |
| PAGE INDUSTRIES LTD | 341.5 | 781.9 | 43.7% |
| CHOLAMANDALAM INVESTMENT AND | 13.9 | 57.8 | 24.1% |
| CITY UNION BANK LTD | 6.6 | 51.1 | 13.0% |
| VINATI ORGANICS LTD | 46.9 | 195.2 | 24.0% |
| REDINGTON INDIA LTD | 8.1 | 74.2 | 11.0% |
| ALKYL AMINES CHEMICALS LTD | 36.3 | 175.3 | 20.7% |
| REPCO HOME FINANCE LTD | 29.8 | 203.4 | 14.6% |
| MUTHOOT CAPITAL SERVICES LTD | 42.0 | 177.9 | 23.6% |
| KAMDHENU LTD | 7.9 | 35.8 | 22.0% |
There are several marquee names in the above list which are investor favourites and their lofty market valuations are possibly justified by the fact that they have been able to generate positive and growing earnings during a period where we have seen multiple economic cycles in India. Very commendable. If we take 15% ROE as a benchmark for India, then except for 3 companies, all the others have performed way above that benchmark. Some food for thought!
** Author name – Vijay Sarathi