15 L Investments in These Cos would’ve Earned 45 L in 5 Yrs

Dr Reddy’s, Cairn among 15 that have improved return on capital employed

Drug maker Dr Reddy’s Labs, truck-financing company, Sriram Transport Finance, oil exploration firm Cairn India and Mcleod Russel feature in a list of 15 companies which have steadily improved their return on capital employed, or RoCE, between FY08 and FY12. RoCE is a measure of how gainfully a company is able to deploy or use its capital. A company which can generate higher profits from a lower capital base will always be better off compared to firm which needs higher capital to generate the same level of profit. In other words, a company with higher RoCE will be preferred over a company with a lower RoCE. This is reflected in the fact that companies with high RoCEs like most leading FMCG companies command premium valuations.
An analysis by the ET Intelligence Group of BSE 500 companies shows that between FY08 and FY12 there were 15 companies which improved their RoCEs, out of which 12 — Bata India, Supreme Industries, Dr Reddy's Labs, Kajaria Ceramics, Shriram Transport Finance, Lupin, Bajaj Finance, Page Industries, M & M Financial, Mcleod Russel, Solar Inds and Cairn India — have emerged as multi-baggers.
Even at the peak of market valuations at the end of 2007, if an investor had bought into each of these stocks by putting in . 100,000, the total investment of . 15 lakh would be worth . 45 lakh today despite the BSE Sensex trading at over 10% below its peak.
It is but natural that leading investment managers often rely on this ratio when taking their investment decisions.
Says Sunil Jain, head of equity research (Retail) at Nirmal Bang Securities, “RoCE is also used for comparing within the peer group while selecting a company for investment. We have seen that the expansion of RoCE generally leads to the expansion of price-to-earnings ratio (P/E). Thus, an investor benefits on two counts. One is through increase in earnings and second is by expansion of P/E. Generally, we avoid recommending stocks with a declining RoCE.”
Says G Chokkalingam, executive director and chief investment manager, Centrum Wealth, “RoCE is a great tool when looking for a defensive investment strategy. “Higher or rising RoCE over the years indicates consistency in growth of both business and profits.”
Although an important tool, RoCE may not always be a pointer to future winners. “This tool has certain limitations – it doesn’t capture possible opportunities arising from turnaround cases, acquisitions or from thematic plays which emerge once in a while in the equity markets,” he said.
Similarly, the market returns of a company also hinge on other variables such as valuation, market sentiment, balance- sheet structure and most importantly future outlook. A rising RoCE indicates robustness of the business – it indicates either rising profitability or a reduction in capital employed. The capital employed can be cut either by reducing the working capital or by paying out excess cashthrough higher dividends.
“Rising RoCE gives glimpse of the performance like growth, management qualities, management’s vision, perception, etc in industry and returns for shareholders in terms of good dividend payouts, safe investment ideas,” says Nilesh Karani, head of research at Magnum Stock Broking.