With Return on Equity( RoE) outlooks at risk, Cost of equity (COE) control strategies to become key drivers
With Return on Equity( RoE) outlooks at risk, Cost of equity (COE) control strategies to become key drivers
In determining share prices, we focus on business strategies that work to increase estimated ROE and curb COE, thereby widening the spread between them. The current consensus view is that interest rates are likely to continue rising in the US and European markets. This has raised the risk of market expectations for ROE – usually an important share price driver – especially in cyclical sectors such as metals & trading. We believe efforts to control COE are now likely to become a more important factor in maintaining and expanding multiples against this backdrop.
Analysis of 44 companies across sectors supports our thesis
Analysis of 44 companies across sectors supports our thesis
In collaboration with the UBS Evidence Lab team, we have analysed the weekly share price performance of 44 companies, including the 14 companies we cover in the metals and trading house sectors as samples over the past 11 years (FY11-FY21). We checked contributions from ROE (one-year forward market consensus) and COE (estimate) based on the level of their coefficients and considered the background to those contributions. Our analysis indicates several cases wherein CoE has functioned as a key share price driver, which supports our view that strategies that can lead to lower betas (such as changes to business portfolios/facility consolidation/balance sheet reinforcement/fixed cost savings/business structure reform) will be critical in helping stocks outperform.
Based on the analysis, we noted cases in which COE in addition to ROE played a role as a share price driver. 1) First phase (FY11-FY14): The economy bottomed but commodity prices fell sharply.
FY11-FY14 was a period of recovery from unprecedented natural disasters including the Great Tohoku Earthquake in March 2011 and severe flooding in Thailand in October 2011. During this period, TOPIX advanced 80%. As a result of monetary easing, forex rates adjusted substantially, from ¥80/$ to ¥120/$, while commodity prices fell from high levels in tandem with supply growth. As a result, expected ROE for stocks sensitive to commodity prices declined sharply.
