No risk, no return By Tony Featherstone, managing editor Friday, February 14, 2003
Stockmarkets, although far from perfect, are usually an efficient indicator of the prospects of economies and companies. In the United States, real interest rates are close to zero and the Government is pumping hundreds of billions of dollars into the economy. Key US equity markets, which should have risen last year in anticipation of a stronger economy, keep falling. The Australian stockmarket recently hit three-year lows, despite a healthy domestic economy and expectations that the global economy will improve in the next 18 months.
Either the markets are wrong or there is a bigger problem ahead. Of course, current market weakness has much to do with the Iraq crisis and the uncertainty it is creating. But to blame all of the market's ills on Iraq clouds a long-term problem: some companies are running out of options to grow and have prospects that do not justify their valuations.
Consider these figures: The return on shareholder funds of Australia's top 1000 enterprises has halved in the past 15 years to 6.7% in 2001-02. More than half of the 251 listed companies in the top 1000 have generated returns below the average cost of equity, the minimum return that shareholders are entitled to expect for making the more risky investment in equities instead of bonds. Only 60 of the 251 exceeded the five-year average cost of equity (10.5%) by more than 2%. More worrying is that many companies are producing returns on their shareholder funds at or below the bond rate.
These figures, compiled by IBISWorld, form the basis of this week's cover story by David James and Andrew Heathcote. BRW commissioned the research to illustrate the problems companies face as demand for their products contracts and as their returns wane. As David notes: "The arithmetic is not encouraging. If the economy is growing at 2-3% and the cost of equity is 10.5%, then companies with a dominant market share have to find productivity growth of about 8% a year just to stand still. In this context it is not possible to be successful just by cutting costs."
At some point, many companies will need to be more aggressive in finding new demand for their products. They will need boards that understand risk and encourage entrepreneurs rather than stifle them. They will need to ensure that their chief executives, many of whom are paid world-competitive salaries, deliver world-competitive returns on their shareholder funds. And they will need to embrace globalisation, rather than avoid it. As one expert quoted in our story warns: "I can think of two very large organisations I have dealt with recently who are perfectly positioned to go and pick up what I would call distressed assets in other parts of the world. There has been a reluctance to do it because of the tyranny of distance."
Stockmarkets, although far from perfect, are usually an efficient indicator of the prospects of economies and companies. In the United States, real interest rates are close to zero and the Government is pumping hundreds of billions of dollars into the economy. Key US equity markets, which should have risen last year in anticipation of a stronger economy, keep falling. The Australian stockmarket recently hit three-year lows, despite a healthy domestic economy and expectations that the global economy will improve in the next 18 months.
