Return on equity for Nifty firms slip to record low of 12.9% in January

Average RoE now at record low of 12.9% as compared to 13.6% a year ago

The return on equity (RoE) ratio for top listed companies continues to deteriorate despite the uptick in earnings growth.
 
The average RoE for the top 50 listed firms, which are a part of the Nifty, has declined to a record low of 12.9 per cent, against 13.6 per cent last year.
 
The ratio was 15.5 per cent in January 2015 and 23.1 per cent in December 2007, on the eve of the big market correction of 2008.
 
In the last one year, the index companies’ underlying earnings per share has risen 3.5 per cent from Rs 401 in January 2018 to around Rs 415 now.
 
Over the same period, book value per share, or net worth, has risen 8.7 per cent — leading to a decline in their return ratio.
 
Analysts attribute this to lower-than-expected profit growth.
 
“Growth in corporate earnings remains below par and will require much faster growth than in the past, to lift the RoE. This is needed to justify the premium valuation that Indian equity enjoys over its global peers,” says Dhananjay Sinha, head of institutional equity Emkay Global Financial Services.
 
For example, Nifty is currently valued at 26 times its trailing 12-month earnings per share, making it second most expensive index after Nasdaq that is trading at 32.6x its trailing 12-month earnings.
 
RoE is calculated by dividing a firm’s net profits (in trailing 12 months) by its latest net worth. A higher ratio means the company is better in generating profits from its assets and vice-versa.
 
Companies with higher RoE command premium valuation over others.

 
In the past, companies have seen a quick uptick in RoE whenever earnings growth has picked up.
 
For example, index companies saw a sharp rise in their RoR beginning 2003, as corporate earnings growth picked up pace during the period.
 

The average RoE for Nifty firms expanded from 16 per cent in early 2003 to around 27 per cent by mid-2005, and stayed at level for the next two years.
 
Bulls expect similar upside in earnings from over the next two years. For example, brokerages expect index companies to report 14.82 per cent and 21.6 per cent earnings growth in FY19 and FY20, according to Bloomberg consensus estimates.
 
This is nearly double the expected earnings growth for S&P 500 index.
 
A lower-than-expected earnings growth and resulting poor RoE could, however, put pressure on equity indices just like 2008, and after crisis sell-off in late 2010 and early 2011.