Growth Leads To Value Creation
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Investors with low risk appetite seeking steady returns can focus on companies in healthcare sector as the data suggest that this sector has very stable growth in revenue and earnings.
Value-investing is an art of arriving at the value of company using its future cash flows. One of the cornerstones of business valuation is growth. When an analyst makes a model of the company for calculating its value the backbone of the model is the assumption of growth. Industry also gives weightage to the analyst who predicts more accurately than others. In this article we will focus on industries which are showing more growth in terms of revenue and earnings as we can expect these industries to do better in the future.
Revenue growth is the key but if the revenue growth does not translate into earnings growth then it does not benefit the shareholder. We constantly hear COO, CFO talking of plans to increase the revenue and if they are suspecting growth to be lower than we would see an immediate reaction to the news.Management of few companies do share guidance numbers on expected revenue and earnings this avoids any earnings surprises when the quarterly results are disclosed.
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Let’s first look at which industry contributes how much to the total revenue and earnings of companies listed in India. For analysis we considered a sample of 1000 companies listed on BSE/NSE based on market capitalization. Out of these companies we selected companies which have reported audited number for 2016 and have been consistent in reporting annual numbers between 2012-2016. Companies which changed their financial year were dropped from the sample. We obtained data of 131 companies as on the date of study (15 July 2016). For calculating proportionate share of revenue and earnings, we added revenue and earnings of all companies and calculated their proportionate share. CAGR of price was calculated using the price data on 15 July 2012 and 15 July 2016.
| Table-1: Proportionate Share of Revenue and Earnings for 2016 |
| Number of companies | Revenue | Earnings | CAGR of Price 2012-2016 |
| Basic Materials | 10 | 8% | 3% | 28% |
| Consumer Goods | 28 | 10% | 20% | 32% |
| Consumer Services | 7 | 1% | 2% | 35% |
| Financials | 37 | 54% | 30% | 18% |
| Health Care | 10 | 3% | 13% | 47% |
| Industrials | 24 | 7% | 20% | 31% |
| Oil & Gas | 2 | 0% | -1% | -7% |
| Technology | 11 | 16% | 13% | 35% |
| Utilities | 2 | 1% | 1% | 8% |
| Grand Total | 131 | 100% | 100% | 28% |
Table-1 indicates that Financial sector contributes maximum revenue and earnings, but since this sector is facing issues regarding Non-performing assets, capital infusion in public sector banks etc. there would be some volatility in this sector. Sector with high contribution to earnings are consumer goods, industrial, technology and healthcare. Healthcare sector contributes 3% to the revenue and 13% to the earnings indicating the high profit potential. Moreover, if we look at average growth in share price of healthcare sector of the last four years, CAGR of 47% is the highest as compared to all other sectors.
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In order analyse growth within these industries we calculated Year on year (YOY) growth of revenue and earnings(EPS) and obtained median values with the industries.
| Table-2: Median Values of YOY Growth in Revenue and Earning across Industries |
| | Revenue Growth | Earnings Growth |
| | 2016 | 2015 | 2014 | 2013 | 2016 | 2015 | 2014 | 2013 |
| Basic Materials | -13% | 6% | 22% | 14% | -2% | 11% | 22% | 22% |
| Consumer Goods | 7% | 10% | 13% | 12% | 14% | 13% | 10% | 11% |
| Consumer Services | 15% | 13% | 19% | 11% | 0% | 4% | 10% | 5% |
| Financials | 9% | 13% | 13% | 20% | 3% | 4% | 0% | 18% |
| Health Care | 15% | 13% | 17% | 18% | 29% | 13% | 28% | 31% |
| Industrials | 5% | 10% | 15% | 12% | 23% | 16% | 11% | 7% |
| Oil & Gas | -5% | 1% | 4% | 1% | -181% | -36% | -3% | 35% |
| Technology | 9% | 10% | 12% | 23% | 1% | -2% | 2% | 15% |
| Utilities | 15% | 13% | 23% | 21% | 17% | 0% | 30% | 14% |
| All Companies | 8% | 11% | 15% | 16% | 9% | 9% | 7% | 17% |
As we can see overall revenue growth of 8% in 2016 is lower as compared to previous years and this is not a great signal for equity markets. Earnings growth of 9% can be considered somewhat in line with the last two years. When we compare growth in revenue within industries we see that maximum growth is happening in Consumer services, healthcare and Utilities. But as we discussed that valuation is driven by cash flows and so revenue growth should translate in earnings growth we see that in consumer services earnings growth is almost 0%, this indicates that revenue growth is happening but cost is also growing in the same proportion.
Earnings growths are very volatile for Utilities; in 2015 there was a 0% growth which has increased to 17%. Healthcare is the only sector which has more consistency of revenue and earnings growth.
Investors with low risk appetite seekingsteady returns can focus on companies in healthcare sector as the data suggest that this sector has very stable growth in revenue and earnings and in the long run will create value for shareholders.