Total shareholder return is rate of return earned by an investor by investing in stocks of Companies during the investment period. An investor investing in stocks makes money in two ways;
- First is the capital appreciation or loss from rise or fall in the share price of the Company.
- Second is the dividends earned on the stocks (Dividend yield)
TSR is an effective metric from investors perspective to compare the performance of stock returns of different Companies. Share price performance comparison itself may not give the correct picture, as the performance of companies may differ in share price appreciation and dividend yield.
Few Companies may have high share price percent change and low dividend yield, while price of other Companies may have low share price percent change and high dividend yield.
TSR for one year is calculated as
Let us understand with help of a simple example.
Suppose you have purchased one share of ABC Limited for $100 on 1st Jan 2019. On 31st Dec 2019, the share price is $112. You also earned $5 as dividend during the year.
The Share price return in this case is 12%
Dividend yield is 5%
Total shareholder return for the year is 17%.
Drivers of Total Shareholder returns
If we multiply share price and EPS by no. of outstanding shares, we get Company level TSR (See figure below).
Now let us discuss the factors which could impact the net income growth and multiplesof a company and thus drive its TSR performance.
Earnings growth could be from revenue growth, cost reduction/ margin increase, capital efficiency and leverage.
Revenue growth is driven by increase in prices or volume growth. A company’s strategy may differ depending on the industry it caters to.
For example: Indian telecom players first reduced prices drastically to acquire customers. However, once the industry got consolidated the players gradually increased prices. Their strategy changed completely within few years. First they reduced prices for customer base growth and then improved revenues through price increase.
A Pharma or High-Tech Company may grow through new product innovation (medicines or technological breakthrough), while a retail or CPG company may grow by expanding in other geographies.
Growth in volume/ revenues is important to increase earnings and hence cash flows of companies. However, all growth is not equally value creating. Growth through acquisitions may not be beneficial to shareholders if the acquiring company pays huge acquisition premium and does not realize full synergy benefits. Such growth may result in negative TSR.
Cost reduction/ Margin improvement
Returns to shareholders are positive when return on invested capital is above cost of capital. Returns are driven by margin and capital productivity/ efficiency.
Let us first discuss margin improvement through cost reduction. Cost reduction is important to maintain or grow margins.
Companies across most industries have started focusing on cost reduction to improve margins. Earlier the focus was just to reduce the G&A costs by outsourcing administrative costs to low cost locations (like India, China etc.). However, with increasing competition, many Companies across the globe have started focusing on cost reduction through use of technology. Spend management through efficient use of technology, Artificial Intelligence and machine learning,Optimizing their Sales and marketing processes and automation.
Just like all growth is not value creating, all types of cost reduction may also not be good for corporates. For example; If a CPG company reduces its advertisement and marketing expenses its margin may improve temporarily but gradually the reduced marketing cost would reflect in reduced sales for the company. Similarly, a Pharma or High Tech Company can’t reduce their R&D cost as it would impact new product innovation and hence growth of the Company.
Investors should judiciously understand how the company has reduced cost as all types of cost reduction may not be equally beneficial.
Efficient use of capital is an important driver of cash flows and Return on Invested Capital. Working capital and capex management are important drivers to efficient use of capital. Companies are focusing on improving their revenue cycle so as to improve their Days sales Outstanding, using efficient supply chain across the value chain to improve inventory management.
A thorough analysis of investment in Property plant and equipment or investment in acquisition should be done to ensure that it is cash flow positive for investors.
Leverage may also result in EPS growth and higher shareholder returns as cost of debt is low compared to cost of equity. However, as the leverage increases the risk for the shareholders also increases.
An investor should understand the risk he wants to take by investing in a highly leveraged company, as leverage has an amplifying impact on TSR.
Two Companies, having same operating profits may have different TSR because of leverage. The one with leverage will generate a higher TSR. However, in case of losses, the Company with low leverage will perform better.
Therefore, an investor should understand the risk and return well before investing in a leveraged company.
P/E multiples are driven by investor expectations.
Investor expectations on future performance of the Company is a critical driver of TSR. A company which has delivered high growth and return on invested capital in the past may not deliver high TSR, if investors expect decline in operating performance of the company going forward due to changing consumer preferences, or change in economic scenario or due to change in management priorities. Decline in expectations on future performance would be reflected in declining P/E multiple of the Company and hence on TSR.
A Company with high investor expectations on future performance will deliver high TSR. Take the example of Netflix. Netflix has delivered high growth, but low or negative returns/cash flows in the past as it is investing heavily in online content for growth.
With increasing preference for online video content it is expected to deliver exponential growth in cash flows, which is reflected in share price performance of the during past few years (See Share price performance vs S&P 500). In the last 5 years, Netflix has delivered 378% returns as compared to 55% by S&P 500. High valuations are driven primarily by high expectations around future performance.
Pharma industry in India is another example of change in investor expectations. Before the Pandemic, the industry was facing multiple headwinds in the form of Regulations, Pricing pressure, Quality issues etc. But since the outbreak of Covid 19, investors expect the Pharma Companies to perform better due to rising demand. Change in investor sentiments is reflected in the increased multiple for Pharma Companies. See below the performance of NIFTY Pharma Index Vs NIFTY 50. NIFTY Pharma has delivered 24% YTD returns whereas NIFTY 50 has delivered negative returns (-16%).
As discussed earlier, Dividend yield is important to calculate TSR. However, it is not a driver of TSR. Dividend is paid by Corporates out of the cash proceeds generated from the business after meeting the capex requirements and paying off the financial liabilities.
A company making high investment in future growth may not have cash to pay dividends and yet generate high TSR as growth investment today would result in higher cash flows in the future.
A company with high cash flows in a mature industry (Eg. Power Generation Company) may have low or no growth opportunity. Such Company’s pay high dividend to shareholders as they do not want to retain cash due to limited growth opportunities. TSR for such Companies are relatively stable as investors do not expect much improvement in Earnings growth.
Breakup of TSR shows why we should focus investing in Cos. with high growth, high margins and returns above cost of capital. Operating performance and investor expectations are the two main drivers behind TSR performance of Companies.
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