Generating appropriate return on equity

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I recently re-read an old article I had filed away that addressed the topic of corporate Australia’s poor performance regarding generating an appropriate return on equity. Phil Ruthven presented his views on the topic in an open and honest way, that made for a refreshing read.

Over the past forty years, Ruthven has been a leading figure in business, with IBIS one of his key success stories. He has seen it all and to me, his views provide great insight into the past and the future.

Ruthven believes that since the 1960’s, companies have been distracted from the importance of the “return on equity” metric. Instead, they have been focused on diversification and investing in hard assets. It is his view that true value is actually found in their intellectual property, not expensive long-term assets!

Executives fall in love with physical assets, Ruthven says. “This is an obsession for managers in Australia and it is a mistake because things like land and buildings can always be leased. The real value and focus for companies should be intellectual property”.

One critical example he cites is Cochlear Ltd which he believes rates intellectual property higher than any other.

His arguments are backed by data such which shows Australia’s top 1000 companies return on average less than 8% on their total equity (20% ROE is his benchmark). He argues many passive investments earn more!

He is so passionate about this topic, he has set about building a national institute to focus on it!

As I travel and meet with some of Australia’s leading CFO’s, it’s clear to me that as bank capital becomes scarcer, financial leaders are focusing on what they invest in and the returns these investments generate. However, are they focused enough on lifting returns to 20%?

At Maia Financial, our ROE challenge is to provide more financial support and products to assist our clients in solving this problem – not an easy challenge to overcome. With global capital more transient and not aligned to country and state, I personally believe this challenge is more important than we think. If Australian businesses fail to generate the returns required to attract it, our growth slows and financial options decrease.

As leaders we all compete for capital, to win in this race, we must improve the returns we generate from it. To me this is the simple challenge, however, the answer is much more complicated.