Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 202

What matters most? A good industry or a good management?

With the 2017 Federal Budget targeting the profits of banks for a special levy, and questions about who’s next, let’s take a look at business profitability and shatter some myths. There are misunderstandings about excess profits that some well-intentioned but uninformed or envious people suggest are the norm, but aren’t.

There are thousands of good and truly impressive performers among our 840,000 employing-businesses in Australia. It’s a tiny minority indeed, but a minority we would surely all like to become more mainstream.

The business of business

Businesses are started for all sorts of reasons: to buy a job; to satisfy an entrepreneurial or freedom-seeking passion; or to make more money than in a job, via profits on top of a wage or salary. Most don’t achieve any of these. We currently have around 2.1 million businesses in Australia according to the ABS. Some 280,000 start up each year and nearly the same number close each year, mostly within three years of commencement. About 78% of businesses, on average, make a profit each year, 2% break even and 20% run at a loss. It’s tough.

The average profit of the businesses other than general government - in terms of the net return after tax on shareholder funds (ROSF) - has averaged just over 5% over the past 30 years, or about the same as the 10-year bond rate over the same period.

Surely it is much better among our big corporations, say the 1,500 biggest, accounting for around 42% of the nation’s revenue. Sadly, no. Over the past five years, their average has been just 8.7%, or much the same as the return on commercial property which is a passive asset. Some 20% of these 1,500 giants ran at a loss over the five-year period. Yes, one in five.

The 100 worst loss-making enterprises ranged from a five-year average ROSF of minus 16% pa to more than ten times that annual loss. The average over the 100 or so corporations was minus 44.7% pa, although slightly-less scary on a weighted average basis at minus 30.0%. These 100 negative earners were evenly split between foreign and local corporations. Almost one in five of the 100 were caught unprepared for the minerals prices collapse over this five-year period.

Of course, a number of them were investing heavily for the very long term and they could not be considered mismanaged.

Our 100 best government businesses, made up of Government Business Enterprises (GBEs) and general government organisations, fared a lot better, and had an average ROSF of 9.8% over the five years to 2016. Eleven of them achieved world best practice profitability of 20% or more. Around 80% of them bettered the average 10-year bond rate (3.1%) over this period. That’s no mean achievement for government enterprises, and half of the best 100 are listed below.

profitability

profitability

Performance of other clusters of companies

The 100 biggest corporations that account for just under one fifth (19%) of the nation’s revenue had an average ROSF of 11.6%, but only 8.4% on a weighted basis – also around the passive return on commercial property. Almost one in seven (18%) ran at a loss over the five-year period.

Cutting company taxes a bit wouldn’t improve this awful performance much. Why just get a 7% improvement to the bottom line by cutting the tax rate from 30% to 25%, when knowing how to achieve world’s best practice (WBP) profitability could double or even quadruple the bottom line, as well as the top line, profit.

Let’s look into serious territory where WBP profitability is common rather than scarce.

Our 100 best listed public companies on the ASX had an average ROSF of 23.3% over the five years to 2016. Some 47 of these had an average over 20%, matching WBP. Among those in the top 10 were: Tamawood (house construction), Platinum (funds management), Blackmores (vitamins), the Dulux Group (paint manufacture), Cochlear (hearing implants) and Telstra (telecommunications). These and a dozen others achieved over 30% in their returns on shareholder funds after tax over the five years to 2016.

The 100 best local private companies’ average ROSF, at 26.4%, was even better, not by a lot, but over half (53) did better than WBP over the five-year period. Names that are familiar to most include: Wotif; Lorna Jane; Penfolds Motors; Carpet Call; the GHD Group and Kennards Hire.

The 100 best foreign companies averaged a much higher 51.3% ROSF over five years, or double the 100 best public listed corporations and nearly double the 100 best privates. All 100 beat the cut-off for WBP profitability in ROSF terms at over 20%. There are a lot of well-known and household names in this list, including: Bechtel; Hilton International; FedEx; Diageo; Philips; Colgate Palmolive; Nestle and Apple.

The 100 Best Companies over the five years, regardless of the type of company or ownership, saw the average ROSF jump to a staggering 62.9%. But the best 100 have averaged well over 30% for decades, without suggesting they have always been the same companies. That doesn’t happen: companies get taken over; split up or new management breaks the rules of success that got the company there in the first place.

Types of ownership do not matter much

What is particularly interesting about the outstanding performance of these companies is that there is very little difference in profitability between types of ownership, locality of ownership (local or foreign) or industries.

profitability

Indeed, when it comes to industries, they imply there is no such thing as a ‘bad’ industry, only inadequate or inappropriate management. In fact, three of the best 100 were in mining, whereas there were 18 miners in the 100 worst companies during a time when mineral prices plummeted. And there were 16 manufacturers in the best 100 list, an industry considered to be one of the toughest around these days.

The ladder below is an interesting one in this regard.

profitability

These returns are way above the entry level of WBP profitability of 20% ROSF where the winners are to be found, and should not be seen as the yardstick of success. Too few can ever achieve these best 100 levels, and it is not expected. Achieving 20%, consistently, will do just fine.

 

Phil Ruthven is Founder of IBISWorld and is recognised as one of Australia’s foremost business strategists and futurists.

RELATED ARTICLES

Why August company reporting season was poor

Buffett and his warning about 'virtually certain' earnings

18 Aussie names for your watchlist

banner

Most viewed in recent weeks

10 little-known pension traps prove the value of advice

Most people entering retirement do not see a financial adviser, mainly due to cost. It's a major problem because there are small mistakes a retiree can make which are expensive and avoidable if a few tips were known.

Check eligibility for the Commonwealth Seniors Health Card

Eligibility for the Commonwealth Seniors Health Card has no asset test and a relatively high income test. It's worth checking eligibility and the benefits of qualifying to save on the cost of medications.

Hamish Douglass on why the movie hasn’t ended yet

The focus is on Magellan for its investment performance and departure of the CEO, but Douglass says the pandemic, inflation, rising rates and Middle East tensions have not played out. Vindication is always long term.

Start the year right with the 2022 Retiree Checklist

This is our annual checklist of what retirees need to be aware of in 2022. It is a long list of 25 items and not everything will apply to your situation. Run your eye over the benefits and entitlements.

At 98-years-old, Charlie Munger still delivers the one-liners

The Warren Buffett/Charlie Munger partnership is the stuff of legends, but even Charlie admits it is coming to an end ("I'm nearly dead"). He is one of the few people in investing prepared to say what he thinks.

Should I pay off the mortgage or top up my superannuation?

Depending on personal circumstances, it may be time to rethink the bias to paying down housing debt over wealth accumulation in super. Do the sums and ask these four questions to plan for your future.

Latest Updates

Investment strategies

Three ways index investing masks extra risk

There are thousands of different indexes, and they are not all diversified and broadly-based. Watch for concentration risk in sectors and companies, and know the underlying assets in case liquidity is needed.

Investment strategies

Will 2022 be the year for quality companies?

It is easy to feel like an investing genius over the last 10 years, with most asset classes making wonderful gains. But if there's a setback, companies like Reece, ARB, Cochlear, REA Group and CSL will recover best.

Shares

2022 outlook: buy a raincoat but don't put it on yet

In the 11th year of a bull market, near the end of the cycle, some type of correction is likely. Underneath is solid, healthy and underpinned by strong earnings growth, but there's less room for mistakes.

Gold

Time to give up on gold?

In 2021, the gold price failed to sustain its strong rise since 2018, although it recovered after early losses. But where does gold sit in a world of inflation, rising rates and a competitor like Bitcoin?

Investment strategies

Global leaders reveal surprises of 2021, challenges for 2022

In a sentence or two, global experts across many fields are asked to summarise the biggest surprise of 2021, and enduring challenges into 2022. It's a short and sweet view of the changes we are all facing.

Shares

What were the big stockmarket listings in record 2021?

In 2021, sharemarket gains supported record levels of capital raisings and IPOs in Australia. The range of deals listed here shows the maturity of the local market in providing equity capital.

Economy

Let 'er rip: how high can debt-to-GDP ratios soar?

Governments and investors have been complacent about the build up of debt, but at some level, a ceiling exists. Are we near yet? Trouble is brewing, especially in the eurozone and emerging countries.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.