The return on equity for Indian companies is likely to head lower before it improves even through they are at their lowest since the early 2000s.
Although return on equity, a key measure of profitability, is at its lowest in ten years, it is well within the average for the previous decade, noted Barclay Capital’s India equity strategy report dated 29th August.
“While current ROEs are at the past 10-year bottom, they are still only at the average level of the FY94-03 period. Given the risk to growth, and with ROEs of cyclical sectors still significantly above their last 20-year trough, we believe it could be early to call a cyclical bottom for ROEs,” said the note prepared by Bhuvnesh Singh, Vijit Jain and Kunal Agarwal.
The previous reign of high growth rates could be attributed to an easy funding environment, according to the trio which based their observations on data for 650 corporates stretching back twenty years. It noted that revenue and asset growth was 300-400 basis points higher in the last decade than the decade before that. Also, return on equity was up 500 basis points ‘largely on the back of lower interest/depreciation expense.’
“Going forward, with constraints on global funding, asset growth rates could slow and interest/depreciation costs should rise. This would be negative for ROEs and valuations,” they said.
