New age investing: Look for productivity not monopoly
A few weeks ago, The Economist published a story claiming that India’s largest 20 profit generating companies account for 70% of corporate profits. In contrast, the top 20 companies in the 90s contributed just 15% of corporate profits.
Does this, in a way, justify Indian equity markets being driven by a handful of companies?
Some economists and stock market experts are highlighting the growing dominance of capitalist cronies (companies that leverage their political nexus) in India’s corporate sector. They also suggest that tighter compliance and technological disruptions favour these big guns and work against smaller players (which actually create majority of jobs).
Lopsided systems aren’t desirable, beyond a doubt, but will offering ease in compliance fix any real issue? Unlikely! Similarly, is access to disrupting technologies a surefire strategy to success?
The problem of crony capitalism is rather chronic and deep-rooted. Businesses always have a give-and-take relationship with societies and governments.
Companies chase opportunities and talent chases successful companies. Not so surprisingly then, some companies become popular at college campuses. They also become strategically important because they not only create direct and indirect employment opportunities but help governments execute their developmental agenda and compete at the international level.
Factors other than tight regulations and technological disruptions that create cronies are:
- Better access to talent
- Ability to retain talent and offer a career map to employees
- Better access to opportunities
- Financial muscle to ride out tough times
Fixing cronies and creating a balanced socio-economic environment requires better policy coordination between the government and corporates.
We often hear a typical political rhetoric—India needs to invest in education and create enough jobs for youth. But why does it always remain an unfinished agenda? Well, job creation is subject to TECO—Talent, Employability, Capital and Opportunity.
We stick our neck out and say availability of financial capital has become less of a concern today. To attract capital, companies either need a proven track record or a promising story. In fact, the judicious use of capital has become extremely crucial.
GDP, Job creation, education, social security, corporate profits, markets… all these topics are interconnected. Unfortunately, we often deal with them individually.
If the Indian industry isn’t architected to sustain even 3 months of below zero revenue how fair is it to expect higher job security? And if many small businesses in India are facing competency issues, how can we expect them to still create jobs and contribute incrementally in India’s GDP?
No surprise then, only a few big listed players manage to grow and attract investors. Big gets bigger and expensively valued companies get even more expensive in the stock market.
Does that mean investors should look for monopolies to identify multibaggers?
Time to run a mirror check
Since biggies compete with world class companies, they have stringent productivity and competence criteria that a vast majority of Indian youth find tough to meet. According to India Skills report, only 46% of students were employable in 2019 and this figure has grown in proportion since 2014, when it was lower, at 33%. Improving employability is a daunting task.
This is not to say that Indian youth lack talent. It simply means they are not yet fully geared up to deliver what the competition demands from them.
What’s the solution?
India will have to undertake not only serious educational reforms but will also have to change the perspective about job creation simultaneously. India’s education agenda should move beyond literacy and classroom education to a greater focus on employability and productivity. Skill development programs are just one aspect of it.
On this backdrop, we looked at data of Nifty 50 companies dispassionately, to understand employment and productivity trends.
The findings are startling
- Nifty 50 companies provide employment opportunities to approximately 37 lakh individuals, which include 26.9 lakh permanent employees. In other words less than 1% of India’s working age population works with these 50 companies. That said, these companies create many jobs indirectly. What’s their contribution to corporate profits? No scale to measure it so far.
- The top 20 companies, based on profit earned over the last 4 quarters, employ 27.4 lakh individuals and account for 84% of net profits earned by Nifty 50 companies.
- On an average, Nifty 50 companies earn Rs 10 lakh of net profit for every person they employ. You will be surprised to know, they incur a cost of Rs 15 lakh per employee on an average—juxtaposed with India’s per capita income of Rs 1.35 lakh. No wonder those working in India’s top 50 listed companies have a very high purchasing power as compared to the rest. Cronies not just attract capital but talent too—reiteration of what we said earlier.
- Just 31 companies earned a higher net profit per employee than cost they incurred on every employee. The list was further filtered by applying a criterion of 15% ROCE (Return on Capital Employed). While leading IT companies earn a higher ROCE, they flunk on employee productivity count.
- And this will raise many eyebrows; employees of some PSUs generate higher profits for their respective companies than what they get in return.
In short, even the frontline Indian companies have a lot of room to improve their productivity by utilizing their human capital more effectively—perhaps a productivity draught even at the corporate leadership level too.
Making the best use of resources…
Do bigger companies offer better job security?
LinkedIn’s biweekly Workforce Confidence Index stood at +49 (for the period between May 04, 2020 and May 31, 2020) on a scale of -100 to +100. It was observed that, employees working with large enterprises (ones that provide employment to more than 10,000 people) were more confident about their job prospects than their counterparts (during the times of pandemic).
Since adequate compensation and job security are critical considerations for those who are employable, their preferring to work with bigger organisations appears a corollary. Smaller companies lack access to talent—area that often remains neglected.
Employability, productivity and job creation is a real battle that India must win. Otherwise, it will be a daunting task to erase the inequality between the per capita income of the employees of bigger corporations and that of the rest of Indians. Unless general income levels grow, corporate profits can’t grow. Will not that stop the compounding machine of corporate India?
Takeaways for investors…
Good governance, profitability and a dominant market share has made some companies continuous compounders, true! However, our findings bust some myths too. Productivity of resources, not monopolies create compounders. In fact, monopolies tend to make companies lazy.
For the Indian consumption story to make further progress, a country’s per capita income has to increase substantially. And it’s unlikely to increase unless employability and productivity of India’s human capital improves.
Finding value in a company goes much beyond PE, PB and ROCE ratios. Changing times demand a much needed change in the evaluation matrices.
The Coronavirus pandemic has shaken the world upside down and has compelled industry leaders to rework cost structures. In this scheme of things, a big leap in the job market is unlikely to come from big companies.
You see, real investing starts where theories give up!
For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments—Warren Buffet
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We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:
We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflicts of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.