Higher ROE & ROA Are Keys to Higher Valuation, but This Wasn’t Easy for Companies with Low Valuation

I would like to examine which companies have experienced an increase in stock valuations over the past year, and have analyzed the characteristics of the 1,755 companies in the comparable Metrical universe whose Tobin’s Q increased between the end of December 2022 and the end of December 2023. The table below shows the median value of the change in Tobin’s Q for each of the six groups.

Across all 1,755 companies, Tobin’s Q increased by a median of 0.01 over the past year. Groups that increased Tobin’s Q by 0.10 or more improved their average ROE and ROA on a median basis over the past three years. Groups that did not increase ROE and ROA also did not increase Tobin’s Q. Compared to the group that did not increase ROE and ROA and had an increase in Tobin’s Q smaller than 0.1, the group that increased Tobin’s Q by 0.10 or more had a higher overall corporate governance score, the Metrical CG score, and the percentage of foreign ownership also increased slightly. The groups with larger increases in Tobin’s Q can be seen to have made progress in their efforts to improve corporate governance practices. Since the foreign shareholding ratios increased slightly in these groups, it confirms the tendency of overseas investors to invest in companies that have made progress in improving their ROE and ROA.

In the end, the bottom line is that improving ROE and ROA is more important than anything else to raise Tobin’s Q or stock price valuations. 2023 saw a lot of attention paid to raising P/B at the request of the TSE. Consequently, stock price valuations did not increase much for listed companies as a whole. Among those companies that were able to increase their stock price valuations were those that improved their ROE and ROA. This suggests that the focus of the AGM and engagements from overseas investors in 2024 will surely be on improving ROE by strengthening profitability (ROA) and shareholder returns.

Looking at the profile on the right side of the table above, it can be seen that many of the groups that increased Tobin’s Q were originally companies with high Tobin’s Q, and were also originally high in ROE and ROA. In other words, we can see that companies with higher stock price valuations and higher ROE and ROA have increased their profitability, resulting in higher stock price valuations. It can also be seen that companies with higher Tobin’s Q have increased their ROE and ROA, resulting in higher stock price valuations. It can be said that companies with an originally low Tobin’s Q were unable to increase their ROE and ROA, and thus were unable to raise their stock valuations. Companies with lower Tobin’s Q include many companies with smaller market capitalizations. The ROE and ROA of these companies were flat over the past year. However, compared to the group whose Tobin’s Q change was flat or increased by only 0.1, the ROE and ROA of these companies are higher, so we would expect some of these companies to go private through MBOs.

In summary, I have considered what companies have increased their stock valuations over the year 2023.

Tobin’s Q increased only slightly over the past year, +0.01 on a median basis. The group that increased Tobin’s Q by 0.10 or more had higher average ROE and ROA over the past three years, while the group with flat or declining Tobin’s Q had no increase in ROE and ROA. The group that increased Tobin’s Q by 0.10 or more showed a relative improvement in corporate governance and a slight upward trend in foreign ownership.

Ultimately, the bottom line is that improving ROE and ROA is more important than anything else in raising Tobin’s Q or stock price valuations. The results of this analysis confirm, once again, that improving ROE and ROA is effective in raising stock valuations. This suggests that the focus of AGM and overseas investor engagement in 2024 will be on improving ROE by strengthening profitability (ROA) and shareholder returns.

We can also see that many of the groups that increased their Tobin’s Q were originally companies with high Tobin’s Q and were also originally high in ROE and ROA. In other words, we can see that companies with higher stock price valuations and higher ROE and ROA have increased their stock price valuations as a result of more earnings growth. This confirms that it is not easy to immediately raise ROE and ROA simply at the request of the TSE.

Companies that have seen their Tobin’s Q decline over the past year include many with small market capitalizations. It is expected that some of these companies will go private through MBOs.

Aki Matsumoto, CFA

Please see detail research the following links.
http://www.metrical.co.jp/
Please feel free to contact the below email address if any interest or query.

Aki Matsumoto, CFA
Executive Director
Metrical Inc.
akimatsumoto@metrical.co.jp
http://www.metrical.co.jp/jp-home/

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