Securing ‘acceptable’ returns

HOW do shareholders know whether a company is delivering an adequate rate of return on their investment? 

Among Western Australia’s top 20 companies by market capitalisation, five-year annual returns to shareholders have ranged from Hardman Resources’ 53.3 per cent to ERG’s -21.9 per cent.

Fellow miners GRD and Jubilee Mines delivered 40 per cent-plus returns, with Bristile the leading industrial delivering 37.5 per cent over five years. 

Wesfarmers and Foodland also delivered in excess of 20 per cent over the same period.

These are impressive results, but what about companies with lesser returns?  What is acceptable?

The starting point with TSR performance is to recognise that shareholder returns are residual returns – dividends paid from profits and capital appreciation based on expectations of future earnings growth. 

All other payments, including those to suppliers, employees and lenders, rank above payments to shareholders. 

Consequently, shareholders exper-ience greater risk than other stake-holders holding claims against the company.

Investors will only hold riskier investments where they provide sufficient additional return. 

The 10-year government bond rate is generally used as a proxy for the risk-free rate of return.

Ten-year bond yields have ranged between 4.6 per cent and 7.3 per cent over the five-year period covered by the TSR survey. 

Investors holding company shares face two additional risks – general equity market risk and unique, stock-specific risk.

The market risk premium (MRP) captures this risk and is typically estimated using historical data. 

In Australia the historical MRP is slightly less than 7 per cent. 

Based in this MRP estimate, stocks exhibiting similar volatility to the equity market as a whole should have delivered a five-year annual TSR of between 11.6 per cent and 14.3 per cent.

Prominent companies falling into this band include Woodside Petroleum, West Australian Newspapers and Futuris, while BankWest and Coventry delivered returns just above this band.

While TSR data is a quality ex-post measure of corporate perfor-mance, it provides only a high level of insight into underlying value drivers.

Consider WA Newspapers with a five-year annual TSR of 12.6 per cent. 

About 80 per cent of this return is attributable to dividends and returns on re-invested dividends. 

WA Newspapers has maintained a high payout ratio, returning company earnings to shareholders over this period. 

Annual share price appreciation has been just 3 per cent.

By way of contrast, dividends and returns on re-invested dividends represented just 41 per cent of Wesfarmers’ total return, while the annual share price appreciation has been a stunning 17 per cent. 

Similar growth by acquisition has been evident in Bristile’s and Foodland’s share price performance.

In summary, companies providing investors with five-year annual TSR performance of between 12 per cent and 15 per cent can be considered solid performers over this timeframe. 

Annual TSR returns in excess of 15 per cent can be regarded as exceptional. 

WA companies that have achieved this level of performance deserve to be regarded as Aust-ralian and global exemplars.

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