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Shareholder returns fall to six year low as UK firms hoard more than GBP1.2trn in capital


The returns UK companies are providing shareholders on their capital have fallen to their lowest level in at least six years, according to the Profit Watch UK report from retail stockbroker The Share Centre. 

Return on equity (ROE) measures the profit generated by the amount of shareholder capital that firms hold.  In the year to the end of June 2008, the return on equity from UK Plc was a very healthy 17.9 per cent. By the year to the end of June 2013, it had plummeted by more than half, to just 8.7 per cent.
The sharp decline reflects two factors. First, the profitability of UK companies has declined remarkably, from GBP136.2bn in the year to the end of June 2008 to just GBP104.0bn this year. At the same time, the amount of capital firms hold has sky-rocketed by a colossal GBP435bn, shooting up from GBP761bn in 2008 to a record GBP1.2trn today. Equity capital can increase either by retaining earnings, or by issuing new shares. This huge increase in capital means it has been retained by companies, instead of flowing back to shareholders to be reinvested in other opportunities.
The effect is very broadly spread. Nine out of the ten main industry groupings have seen return on equity decline. Only consumer goods firms have increased their ROE in the period. At the more detailed sector level, 25 sectors have seen ROE shrink, while only 13 have managed to expand it.
The banks’ return on equity has fallen most dramatically, down by 92 per cent, from 16.1 per cent to 1.3 per cent. This reflects the huge amounts of extra capital regulators now require banks to hold, and also the dramatically lower profits banks are now generating. The banks collectively account for one quarter of UK Plc equity capital.
Food and beverages companies have done well, modestly growing their returns since 2008 (reaching 22.6 per cent and 19.2 per cent respectively). Big firms like SABMiller and Diageo have expanded globally and found new markets for their products. The highest returns on equity can be found in the tobacco sector (33.5 per cent) and pharmaceuticals (37.8 per cent), though both these sectors have seen declines since 2008.
Helal Miah, investment research analyst at The Share Centre, says: “Return on equity is a very important measure of the efficiency with which firms use their shareholders’ capital. On one side, profits have fallen owing to the economic challenges firms have faced since the crisis and subsequent recessions. The other side of the coin, the big increase in equity capital, reflects a major shift in the way firms finance themselves, paying back borrowing and building up equity buffers. Using borrowing effectively can significantly enhance returns for shareholders – just as a mortgage lets a homebuyer use his relatively small deposit to buy a home, so borrowing enables firms to do more with scarce equity. But in 2008 companies began to face difficulties rolling over their borrowings.
“As the recovery gathers pace, returns on equity will rise again, but the culture seems to have changed since the boomtime, and managers and investors seem now prepared to want higher levels of equity finance, and to tolerate lower returns as a result. This has a knock-one effect on the ability of firms to invest and grow. Debt finance is cheaper than equity, so fewer investments create value if they are principally equity financed, and if companies are not prepared to gear up then the sheer quantity of available capital for investment is much reduced as well. This is not helpful for the long term health of the economy.”

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