One year has passed since TSE requested companies to “manage their companies with an awareness of the cost of capital and stock price” (so-called “P/B raise”). As of the end of March, more than half (885) of the prime market listed companies had disclosed their measures, and more companies are expected to do so once the companies whose fiscal year ends in March begin to disclose their measures. In recent disclosures, some companies have broken down their ROE and indicated target values when referring to the cost of capital, partly as a result of TSE’s publication of good practices in disclosure materials.
Two years ago, TSE requested disclosure of countermeasures for companies applying transitional measures that were unable to meet the listing criteria for the prime market and other markets. The challenge for companies applying transitional measures was to increase their stock prices because their market capitalization did not meet the listing criteria (10 billion yen in the case of the prime market). Most of the disclosure materials for the measures were to increase EPS by increasing sales and repurchasing treasury stocks, as well as to increase P/E. Even if EPS was to increase, it would be dependent on preconditions. While EPS growth is dependent on assumptions and therefore subject to many uncertainties, P/E is not something that can be controlled by management and is therefore very unreliable. This is probably why many companies applying the transitional measures could not maintain the listing standards and moved from the prime market to the standard market.
In comparison, there has been an improvement in the format of disclosure materials, and with regard to requests to raise P/B, it is natural that attention is focused on measures to raise ROE, which management can improve on its own, rather than P/E, which is out of its control. Shareholder returns, such as share buybacks, are powerful measures, but many companies are lax in their assumptions for raising profit margins on sales.
The TSE discloses the average ROE for each market every month for ROE trends that have attracted such attention. The following is the trend of the average ROE of companies listed on the prime market. the average ROE has been around 8%, but it declined slightly in March 2024. I would like to analyze ROE, which has not been able to turn upward, even though more and more companies are using it as a KPI for raising P/B.
The Metrical universe of 1,819 companies (March 2024) is divided into six groups (over 15%, over 10% and under 15%, over 8% and under 10%, over 5% and under 8%, over 0% and under 5%, and under 0%) based on the average ROE over the past three years. The table below profiles the Metrical universe of 1,819 companies (March 2024) in six groups divided by ROE. since ROE and ROA are highly correlated, the groups by ROE and median ROA are consistent. As for Tobin’s Q, it shows interesting results. Groups with ROE above 10% have a higher Tobin’s Q. However, companies in the group with ROE between 0% and 10% have a low Tobin’s Q. Conversely, companies in the group with ROE below 0% have a high Tobin’s Q because they include small growth companies that are not profitable. With respect to market capitalization, the group of companies with a low ROE below 5% includes companies with a small market capitalization, while companies with a ROE above 5% do not show a marked difference in market capitalization. A similar trend is observed with respect to foreign shareholdings.
The table below shows the characteristics of board practices in the six groups of ROE: the group with the highest ROE (ROE over 15%) shows superior values in all categories except the nominating committee score. However, it also shows that there is not a marked difference among the ROE groups. The group with ROE between 0% and 8% (ROE is not negative but lower than the prime market average ROE) shows a median Nominating Committee score and Compensation Committee score of 3.00, which suggests that it includes many prime market listed companies (prime market listed companies are required to have the independence of both committees). Although the companies have tried to be formally prepared, there is no sense of intention to shift to a management style that proactively creates value by improving board practices (hence the sluggish ROE).
The table below shows the characteristics of the key actions in the six ROE groups. In the Key Actions, the group with the higher ROE has a better Growth Policy Score, but there is no significant difference in the other evaluation items. The group with ROE over 10% has a low Treasury Stock Retirement Score, while the group with the highest ROE of over 15% has issues with the Dividend Policy Score. It indicates that cash generated from high profitability is not being fully returned to shareholders. The Cash Holding Score is a challenge for both groups.
In summary, more and more companies are using ROE as a KPI in response to “TSE’s request,” but the average ROE of prime market listed companies is still just under 8%. I divided companies into six groups by ROE and considered what characteristics and trends they have.
The Metrical universe of 1,819 companies (March 2024) was divided into six groups by ROE and analyzed in each category. As discussed in my previous articles, “Drivers of Corporate Governance Improvement Are the Percentage of Foreign Shareholdings” and “Engagement Keeps Widening the Profitability Gap Between the Top and Bottom Companies in Market Cap”, unlike the results of the analysis grouped by foreign ownership and market capitalization, the characteristics of companies with high ROE are somewhat vague. The sluggishness of the group with ROE between 0 and 8% is evident. The median ROE over the past three years is 7.3%; the group with an ROE below 0% includes small growth companies, so stock valuations are high. On the other hand, the group with ROE between 0 and 8% has low stock price valuations, indicating that they have not stepped into value-creating management.
It can also be said that this group (companies that are not in the red but have below-average ROE) is likely to include many prime market listed companies, and although they have put in place what is required by the Corporate Governance Code, they have not been able to raise their ROE by taking action on it. TSE is asking these companies to submit assignments.
On the other hand, the group with ROE over 10% is not markedly different from the other groups in Board Practices and Key Actions. This is due to the fact that the foreign shareholdings of this group are not markedly different from the other groups. This is unlike the companies with high foreign ownership, which showed superior values for both corporate governance practices and profitability, as discussed in my previous article. Overseas investor engagement has contributed to raising corporate governance practices and profitability; just because a company has a high ROE does not mean that it will voluntarily improve its corporate governance practices.
http://www.metrical.co.jp/cg-ranking-top100/
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/