Significance of ‘Changes in Equity Statement’

The practice of publishing ‘Changes in Equity Statement’ by Indian Public Listed Companies along with the ‘Balance Sheet’, ‘Profit & Loss’, and ‘Cash flow’ statement is a recent development – FY2017-18 onwards, to be exact. The equity statement doesn’t receive the same level of attention the balance sheet, income, and cash flow statement receive during financial statement analysis: mostly it is excluded from the analysis process.

However, I believe the financial statement analysis should begin with the analysis of the equity statement… because growth in shareholders’ equity and return on shareholders’ equity are essential drivers of stock prices… and the sources of growth and return on shareholders’ equity could be gleaned from the analysis of the equity statement. The insight so derived could apprise us of whether growth and return emanated from the firms’ business operations. Only growth and return that emanate from the firm’s operation create value.

An above-average growth in shareholders’ equity is warranted, but if achieved largely through the issue of equity shares, such growth doesn’t add value. Likewise, a firm might be adding value despite low growth in shareholders’ equity if it distributes a large part of its earnings to shareholders through share buybacks or dividends. All such insights could be gathered through equity statement analysis.

Consider Natural Capsules – a company I recently analysed. The total shareholders’ equity (net worth) of Natural Capsules gained from ₹82.97 crores at the beginning of FY2022-23 to ₹123.22 crores at the end of FY2022-23 – a gain of ₹40.25 crores, or 48.5 percent in percentage terms. Of the total gain, only ₹18.44 crores (46 percent) were contributed by the company’s business operations; the rest, ₹21.81 crores (54 percent) were contributed by shareholder transactions – a fresh issue of equity shares worth ₹22.56 crores less dividend payment of ₹0.77 crores.

In FY2021-22, the net worth grew at a high rate of 33.6 percent, however, equity issuance was responsible for 36.35 percent of the increase in net worth. A quality stock must fulfil two criteria – i) High growth in net worth, and ii) high value of return-on-net-worth – and they should emanate from the firm’s business operations.

By eliminating the equity issuance made in FY2021-22 and FY2022-23, the recalculated net-worth growth was 21.4 percent and 21.3 percent, respectively – still a superior value. Similarly, the recalculated return-on-equity (RoE) was 19.1 percent and 17.8 percent.

Similarly, the composition of shareholders’ equity also could provide valuable information about the company. The share of ‘retained earnings’ in total shareholders’ equity increasing, while at the same time, the share of ‘securities premium’ reducing should be seen as a good sign; while the reverse – share of ‘retained earnings’ declining and share of ‘securities premium’ increasing – should be seen with scepticism.

Though rarely, firms revalue their assets and any increase in value of assets due to revaluation will reflect proportionally on the firm’s shareholders’ equity. Such one-time growths don’t add value; and could be gleaned from the analysis of equity statement.

The equity statement analysis could be a screener too. We should abandon a stock idea that is unworthy of investment – the earlier we know that the better. As the analysis of the equity statement doesn’t require much time… we only need to proceed with a stock idea… if we are convinced about the value-generative nature of the stock’s shareholders’ equity growth and return. This – using equity statement analysis as a screener – can save us valuable time that otherwise could get lost in the analysis of inferior stock ideas.

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