What is India Inc?
‘India Inc.’ is popularly used by the Indian media to refer to the formal (governmental or corporate) sector of the nation. The companies listed under India Inc employed around 7 percent of the Indian workforce in 2000 while contributing to 60% of the nominal GDP of India.
The Ministry of Company Affairs estimates that as of 31st March 2018, there were 17,49,359 companies that made up India Inc. Of these companies, a maximum number were engaged in the Business Services sector (3.56 lakh), succeeded by the Manufacturing sector (2.33 Lakh), the Trading sector (1.52 Lakh) and the Construction Trading sector (1.05 Lakh).
Capital Allocation and Why it Matters
Capital allocation is the structure of distributing and investing a company’s capital or financial resources such that its revenue is maximized. Most firms attempt to allocate their capital such that they can generate the greatest amount of wealth possible for their shareholders. There is a formal structure or policy to allocating capital when it comes to larger companies which is where the term ‘capital allocation policy’ comes from.
Capital Allocation is important because based on where a company decides to use its capital, it may or may not make a profit. The amount of revenue earned by a company is dependent on how much capital is invested as capital and where a company chooses to allocate this capital. Different companies use different capital allocation policies which can dramatically affect returns.
For instance, Infosys recently tweaked its capital allocation policy which now allows shareholders to receive 85% returns as free cash flow. Earlier, without this minor change, shareholders were receiving about 70% in returns. Hence, the capital allocation policy affects how financially viable a company is towards its shareholders.
How to Gauge a Company’s Return on Capital?
Before addressing the capital allocation policies of the best companies under India Inc, here is how earnings of a company are calculated. Namely, there are two parameters to assess how sound a company’s capital allocation policy is based on its earnings:
- Average Return on Capital Employed (ROCE)
- Durability in ROCE
The first parameter is ROCE or ‘Return on Capital Employed’ which is a ratio that helps you gauge the quality of earnings a company has made with respect to the capital invested. ROCE helps in assessing an average of the returns a company has realized from the employed capital. Therefore, ROCE is indicative of how efficiently the capital was used to generate revenue. ROCE divides a company’s earnings without interest and/or tax (EBIT) by the total capital employed.
In addition to ROCE, another key parameter is consistency or durability. In this case, consistency means the ability to stick to one’s average ROCE over a certain duration. Hence, if market fluctuations, economic downturns, or other factors have not changed a company’s average ROCE over time, it is said to be consistent or durable. This duration can be anywhere from 1 month to 5 years. However, the longer a company is able to maintain a high ROCE average, the better it’s capital allocation policy.
India Inc’s Best Capital Allocation Policies
Here are some companies whose capital allocation policy has generated an average high ROCE score over time.
- Hindustan Unilever (HUL)
Hindustan Unilever of HUL is one of the most valued large-cap FMCG companies in India. With a ROCE of 92.3% annually, HUL falls in the top 15 brands under India Inc with the best capital allocation policy. Its durability score is 80/100 which indicates good consistency in its performance.
- Tata Consultancy Services Ltd. (TCS)
Tata Consultancy Services or TCS is another multinational Indian company that is primarily a software and IT-service provider. With a 5-year average ROCE of 55, TCS has delivered consistently good returns to shareholders with respect to capital invested. TCS has medium financial strength at 55/100.
- Castrol India
Castrol India has been a long-time player in the oil manufacturing and distributing industry in India. Its ROCE is currently 93.1 with an impressive average of 120 across 5 years. Its durability is 65/100 indicating high financial strength.
Colgate-Palmolive, another personal products distributor part of India Inc, has also made the list of top annual ROCE companies on the BSE 100. It currently has a ROCE of 70.7 with a P/E ratio of 45.2 indicating high expectations from investors for it to stay consistent or improve over time. It has a good durability score of 65/100.
- Procter & Gamble Hygiene (P&G Hygiene)
A third manufacturer of FMCG in India is P&G Hygiene. Of all the companies mentioned here, P&G holds the highest P/E ratio of 90.63 indicating high expectations when it comes to future returns. It has a relatively consistent ROCE of 62.9 with a high durability score of 60/100.