Return on Equity indicates profitability of a company by measuring how much the shareholders earned for their investment in the company. The higher the percentage, the more efficiently equity base has been utilized, indicating a better return to the Investor.
After a period of flat earnings over FY14-17, we see a semblance of a recovery, with earnings growth estimated at 22 percent for 2HFY18 and 25 percent for FY19, Motilal Oswal said in a report. However, earnings from SBI, Tata Motors, Lupin and ONGC dented sentiment.
Earnings downgrade/upgrade Ratio moderated QoQ in which 65 companies’ saw earnings cut of over 3 percent (58 in 2QFY18) and 43 companies saw earnings upgrades of over 3 percent (49 in 2QFY18). The upgrade/downgrade ratio weakened from 0.84x to 0.66x, said the report.
Markets will continue to give a premium valuation to businesses with high growth visibility, strong return on equity (ROE) and complemented by high standards of corporate governance, suggest experts. Investors should look at stocks which high earnings visibility in the next 1-2 years.
“Future potential of the company is more important than past performance. However, an investor must first judge the capability of the management to en-cash on opportunities which lies ahead of them and projected by them,” Saurabh S Jain, MD, SSJ Finance & Securities told Moneycontrol.
“Companies which are projected over a reasonably long period of time to generate above-average earnings growth and cash flows, supported by high ROE’s, will naturally command higher earnings multiples,” he said.
Return on Equity indicates profitability of a company by measuring how much the shareholders earned for their investment in the company. The higher the percentage, the more efficiently equity base has been utilized, indicating better return to investor.
A recent report by domestic brokerage firm highlighted 10 stocks which are displaying high ROE for FY18. The list includes stocks like Oberoi Realty, Rain Industries, Quess Corp, Hindalco, Tata Motors, Vedanta, Delta Corp, M&M Financial, Escorts, and Avenue Supermarts.
Motilal Oswal expects Hindalco to hit a target of Rs344 in the next one year which translates in to an upside of 40 percent, followed by Quess Corp which should give a return of over 30 percent, and Tata Motors which was a laggard in the last one year could see a rally of about 37 percent in the next 12 months.
The important differentiator which makes these stocks stand out is the EPS CAGR which has been growing at a healthy rate of 40-60 percent. The brokerage firm expects the rate to continue for the period starting from FY17-FY20.
“EPS CAGR is an important driver to predict the future direction of the company. Companies with high EPS CAGR is considered as a good combination for predicting the future prices and movements of the company for valuation aspect. Some of Such companies are Oberoi Realty, Tata Motor, Hindalco and Quess Corp,” Ritesh Ashar – Chief Strategy Officer, KIFS Trade Capital told Moneycontrol.
“When you compare the EPS history with the stock price history, it helps you determine the most likely future direction of the stock price. CAGR is a much bigger factor which will add to a spike in prices. Growth is all we need. A company with great growth potential (CAGR) is considered as one step ahead of the company with High EPS,” he said.
What should investors do?
Investors who are looking for value at current levels even if the stock has corrected in double digits should go for companies which are showing higher earnings growth.
Apart from looking at ROE and PE multiple of the company one can adopt PEG (forward PE to Growth rate) ratio to arrive at a common metric for measuring company valuations to their projected growth rates, suggest experts.
As a simple illustration, a company whose PE ratio is 25 and projected earnings growth is 30%, would give a PEG ratio of 0.83 which would imply that the company is being valued at 0.8x its future growth rate.
“Companies with high growth rates, merely applying the PE ratio alone may not be appropriate and the PEG ratio acts as a good common barometer. As a thumb rule, businesses with growth visibility and having PEG ratio of less than 1, would be considered to be reasonably valued and may be bought with a long-term perspective,” said Jain of SSJ Finance & Securities.
“Companies with good management like Super Avenues Ltd. (DMart) and Titan Ltd. which demonstrate high visibility of future earnings growth and cash flows over a long period of time are seen to have higher PEG ratios,” he said.
However, some analysts say that too much excel sheet projections/forward earnings multiples are harmful for investors and a periodic review of investments is necessary.
“Many times when current valuations are stretched, analysts try to justify them by quoting forward multiples which on the face of it suggests that current valuations are rich enough for one to be cautious,” Jimeet Modi, CEO, Samco Securities told Moneycontrol.
“Looking at one year forward multiple is still ok but going beyond that is an exercise of prediction in which majority fail,” he said.
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