What is the competitive landscape?

As the level of competition and regulation in any sector increases, the fortune of that sector gets impacted.

Knowing the intensity of competition is the key

Type of competition

Perfect competition

Several large buyers and sellers provide similar products and services. For example, for oil marketing companies, HPCL or BPCL, it is hard to differentiate the product offered by these players.

Monopoly

There is only one player. For example, Power grid, a government-owned company is a monopoly in India’s power transmission space.

Oligopoly

In this, a small number of players collude. For example, Pepsi and Coke’s pricing strategy now arrives through collusion rather than a price war.

Monopolistic competition

This is between Perfect Competition and Monopoly. Here, many sellers offer products/ services that are similar but not perfect substitutes of each other i.e., differentiated. A company may earn an above-normal return on capital for some time, but competition soon catches up to drive down returns to the sector average. For example, Crompton Greaves Consumer Electricals Limited is one of the leading FMEG companies in India and enjoys a very high return on capital for now.

An investor must look at the intensity of competitive rivalry, just the number of players may not be indicative of the return.

Role of Regulation

This is a very critical factor to look at. There are sectors such as the power sector, airline, pharma, etc that are heavily regulated. But the IT sector is not heavily regulated. IT firms have more freedom in terms of how they operate. Although in the recent past big IT giants such as Google and Facebook have also come under the regulatory gamut. The cost of compliance increases and the freedom to operate reduces. These things have a negative impact on the return of the company.

Disclaimers

• Investment in securities market are subject to market risks. Read all the related documents carefully before investing.

• The securities quoted are for illustration only and are not recommendatory.

• Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

• Advisor: Ankur Kapur

• SEBI RIA No.: INA100001406

• BASL Member ID: BASL1337

How to calculate the return of a company?

There are many ways to assess the return profile of a company starting from readily available data to a more complex calculation.

RoE or ROCE or ROIC

Return on Capital Employed (ROCE)

It is a firm-level return measure that is calculated by dividing earnings before interest and taxes by the difference between total assets and current liabilities.

You can directly source this from Screener.in for any company.

Reliance Industries ROCE

Nestle India ROCE

Page Industries ROCE

As you can see Reliance Industries has a much lower ROCE than Nestle India and Page Industries. This is no basis for you to allocate in Nestle India or Page, the share price may be too high.

Return on Invested Capital (ROIC)

It is a firm-level return measure that is calculated by dividing Net Operating Profit After Taxes by Invested Capital. This requires a bit of hard work. It requires the investor to read the annual report word by word and understand the segregation between operating i.e. core business and non-operating items.

Here is a calculation of Pidilite ROIC.

Pidilite ROIC

So at one level, you see the break-up of items that makes margin and on the other capital efficiency i.e. how the asset of the business are being used.

Return on Equity (RoE)

This is an equity-level return metric. Du Pont Analysis is a financial framework developed by Du Pont Corporation to break down RoE into insightful components.

Return on Equity = Margin x Asset Turnover x Leverage

Return on Equity = (PAT / Sales) x (Sales / Assets) x (Assets / Net worth)

Du Pont Analysis for Havells India

This analysis can be done by sourcing data from screener.in. The breakup is not directly available but it does not take a long time to source data and perform the calculation.

As an investor starts his/her analysis, ROCE can be analyzed. This way it will help whether it's even worth spending time on the analysis. Reviewing the annual report and performing an ROIC analysis is the best way to understand the return of a company. RoE is useful for financial companies.

Michael J. Mauboussin's article on ROIC <<Click here>>

Disclaimers

• Investment in securities market are subject to market risks. Read all the related documents carefully before investing.

• The securities quoted are for illustration only and are not recommendatory.

• Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

• Advisor: Ankur Kapur

• SEBI RIA No.: INA100001406

• BASL Member ID: BASL1337

What are the company’s cost and margin structure?

The investor must understand the past cost and margin structure and changes in the same. The purpose is to look at the long-term trends of cost and margin. The future is unknown, but this assessment can provide cues as to what can happen in the future.

Here is an example of two companies in the paint sector.

Asian Paints

The operating margin is in the range of 16% - 22%. ROCE ranges from 59%-30% and consistently declining. The decline in the ROCE numbers must be assessed.

Asian Paint's Margins

Asian Paints ROCE

Akzo Nobel

The operating margin is in the range of 8% - 14%. ROCE ranges from 13% - 28%.

Akzo Nobel Margins

Akzo Nobel ROCE

Both these companies operate in the same sector and have to deal with similar competitive forces. But clearly, Asian Paints enjoys a high margin and high ROCE.

Bharti Airtel

Once a leader in the telecom sector enjoys a high operating margin but low ROCE.

Bharti Airtel Margins

Bharti Airtel ROCE

This company may not qualify for the quality tag and as per Buffet’s definition belong to the gruesome category i.e. high Capex requirement and low return on investments.

Disclaimers

• Investment in securities market are subject to market risks. Read all the related documents carefully before investing.

• The securities quoted are for illustration only and are not recommendatory.

• Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

• Advisor: Ankur Kapur

• SEBI RIA No.: INA100001406

• BASL Member ID: BASL1337