“Market IQ”

Understanding the Drivers of

Shareholder Return

Cary Helenius, Kevin Gomes & Graham Taylor

Producing superior Total Shareholder Returns (TSR)* is a

major motivation for ASX listed companies:

• It is the main objective in setting strategic plans

• It should be the main motivation for M&A activity

• It is typically integral in setting remuneration rewards for executives

Limited practical and objective information about the drivers

of TSR has been available for boards and management

The objective of our research was to bridge that

information gap…

2

* “Total Shareholder Return” = Share price change and dividend yields

TSR is affected by a number of factors (“Ps” & “Qs”):

Total Shareholder Return*

Q's

P's

Quantitative – Financials under

company influence

Price (short term) Perception Prospects

3

Management can drive a company’s TSR over future

periods by appropriately managing company financials…

Total Shareholder Return

Q's

P's

Quantitative – Financials under company influence

Price (short term) Perception

Prospects

4

We have explored the relationship between a company’s

reported financials and Relative TSR*…

= 67,500 data points

6 monthly data points over past 10 years

225 companies analysed

We have only included ratios which were clear and objective

measures, derived from the publicly released results

…and found a strong relationship for certain ratios * “Relative TSR” = TSR relative to the market average

5

For example, ROE is a strong driver of Relative TSR

-10%

-5%

0%

5%

10%

Rela

tive T

SR

ROE (increasing --->)

ROE

0%

+ %

- %

6

Re

lati

ve

TS

R

ROE one year prior (increasing --->)

Change in ROE

+ %

0%

- %

Change in ROE is also a strong driver of Relative TSR

7

Re

lati

ve

TS

R

Net debt to equity (increasing --->)

NDE pre GFC

Optimal area

0%

Pre-GFC, “optimal” gearing was rewarded…

8

+ %

- %

-10%

-5%

0%

5%

10%

15%

Rela

tive T

SR

Net debt to equity (increasing --->)

NDE post GFC

+ %

0%

- %

…whilst Post-GFC, the debt relationship changed

9

0

100

200

300

400

500

600

-10%

-5%

0%

5%

10%

15%

2% 3% 4% 5% 6% 8% 10% 12% Exp

osu

re

Re

lative

TSR

Dividend yield

Actual relative TSR Exposure

Actual

0

100

200

300

400

500

600

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

7 10 13 15 18 23 50

Exp

osu

re

Re

lative

TSR

PE (trailing)

Actual relative TSR Exposure

Actual RTSR

-10%

-5%

0%

5%

10%

15%

2% 3% 4% 5% 6% 8% 10% 12%

Rela

tive T

SR

Dividend yield

Price related measures clearly impact Relative TSR on a

one way basis…

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

7 10 13 15 18 23 50

Rela

tive T

SR

PE (trailing)

10

0%

2%

3%

4%

5%

6%

8%

10%

12%

0%

13%

38%

50%

63%

75%

88%

100

%

113

%

Div

iden

d y

ield

Payout Ratio

Low payout high

dividend yield is

associated with

outperformance

High payout low dividend

yield is associated with

underperformance

High Relative TSR

Low Relative TSR

…but 2 way combinations provide additional insight

11

RO

E

(in

cre

as

ing -

-->

)

Change in ROE (increasing --->)

ROE vs Change in ROE

High ROE and high

positive change is

associated with

outperformance

Low ROE and

reduction in ROE is

associated with

underperformance

2 way analysis also provides additional insight into ROE

12

Ye

ar

on

ye

ar

ch

an

ge

net

de

bt

to

eq

uit

y (

incre

as

ing

---

>)

Net debt to equity one year prior (increasing --->)

NDE pre GFC

Relative TSR

outperformance 'sweet

spot' - optimal change in

debt from an optimal

level of debt

The 2 way combination

demonstrates enhanced

performance areas when

considering level of debt and

changes in debt levels

2 way analysis of gearing levels is also insightful…

13

…however, monitoring the factors is critical to detect market

changes

Ye

ar

on

ye

ar

ch

an

ge

net

de

bt

to

eq

uit

y (

incre

as

ing

---

>)

Net debt to equity one year prior (increasing --->)

NDE post GFC The level and change of debt

profile changed significantly

post the GFC

There are some recent signs

that the market is becoming

more comfortable with prudent

levels of debt

14

Taken in combination, the financial ratios were used to

model the Relative TSR

Company Predicted Relative TSR Rank

Predicted Relative TSR Quartile

1. aaa 17 1st

2. bbb 205 4th

3. ccc 115 3rd

… … …

… … …

225. xyz 81 2nd

…with companies ranked and grouped into quartiles

according to their predicted Relative TSR level

Companies in the top quartile represent those

with optimal mix of financial parameters

across P&L, Cashflow and Balance Sheet

a

15

For purposes of our model, price related ratios were excluded

… Financial Ratio P&L Cashflow Balance Sheet Share Price

ROE

Change in ROE

ROFE

NPAT growth

ROFE growth

Net debt to equity

Change in net debt to equity

Net debt to total funds employed

Net interest cover

Pay out ratio

Net cash flow to NPAT

EPS growth

Revenue growth

Dividend Yield

P/E

Price related ratios excluded from our

analysis on the basis that share price is not within

management control

Share price is an output rather than an

input of financial performance.

16

As a group, top quartile companies strongly outperformed…

*Refers to actual Relative TSR recorded over the 12 months following the balance date

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

1st 2nd 3rd 4thRe

lativ

e T

SR

Average Relative TSR* by predicted quartile

Top quartile

strongly

outperformed

(~+9% p.a.)

61% of companies

outperform over

following 12 months

Bottom quartile strongly underperformed (~-7% p.a.)

60% of companies underperform over following 12 months

17

…while bottom quartile companies strongly underperformed

In summary, our research has some important implications…

• Company management can influence TSR outcomes through appropriate financial management

• The reported financials can impact on Relative TSR immediately and endure for the following 12 months

• A significant proportion of Relative TSR performance is attributable to factors independent of share price

• Whilst 1 way analysis of financial ratios provides useful guidance on Relative TSR, 2 way analysis provides significantly greater insights

18

…with a range of potential applications

• An objective framework for assessing management performance and setting executive

remuneration rewards - based on factors which are within management control and

independent of share price

• Allows companies to identify their optimal financial settings (e.g. optimal levels of debt,

dividend payout ratios etc.), with ability to factor in financial constraints

• Used to explore strategic financial objectives for their relevance as Relative TSR drivers and

to to test various strategic alternatives for their impact on predicted Relative TSR ranking

• Identify gaps between predicted and actual Relative TSR performance, prompting further

investigation of possible causes

19

Appendix – Model overview

20

• GLM (normal error term)

• Explanatory variables: Financials

• Response: Relative change in share price plus dividends*

Financials Relative change in TSR eg

* Relative (share price t+1 + dividends t to t+1) / share price t - 1

Appendix – Model validation

21

Model accurately reflects actual

experience over modelled period*

* Modelled period - financials from Jun 2002 to Jun 2010 corresponding to relative TSR from Jun 2003 to Jun 2011

Average Relative TSR

Observation Actual Predicted

1

2

3

4 5

900

901

902

903

904 905

1800

1801

1802 1803

1804 1805

2700

2701

2702

2703

2704 2705

3600

Top 25%

of predicted observatio

ns

2nd predicted

quartile

3rd predicted

quartile

4th predicted

quartile

10% 10%

1% 1%

-2% -3%

-8% -8%

Top 25% of

predicted

observations

2nd predicted

quartile

3rd predicted

quartile

4th predicted

quartile

10% 10%

1% 1%

-2% -3%

-8% -8%

Appendix – Model validation

22 -3%

-2%

-1%

0%

1%

2%

3%

Ju

n 2

003

De

c 2

00

3

Ju

n 2

004

De

c 2

00

4

Ju

n 2

005

De

c 2

00

5

Ju

n 2

006

De

c 2

00

6

Ju

n 2

007

De

c 2

00

7

Ju

n 2

008

De

c 2

00

8

Ju

n 2

009

De

c 2

00

9

Ju

n 2

010

De

c 2

01

0

Ju

n 2

011

De

c 2

01

1

Ju

n 2

012

De

c 2

01

2

Ju

n 2

013

Rela

tive T

SR

Actual vs predicted relative TSR

Actual Predicted Holdout years

Model predicts relative TSR

for year ending Jun 2013

based on financials ending

Jun 2012

Model is robust over time -

including holdout years

Appendix – Model validation

23 -15%

-10%

-5%

0%

5%

10%

15%

Ju

n

200

4

Ju

n

200

5

Ju

n

200

6

Ju

n

200

7

Ju

n

200

8

Ju

n

200

9

Ju

n

201

0

Ju

n

201

1

Ju

n

201

2

Rela

tive T

SR

Actual relative TSR by predicted quartile

1st quartile

2nd quartile

3rd quartile

4th quartile

Over all years 1stquartileOver all years 2ndquartileOver all years 3rdquartile

Holdout year

Top quartile companies consistently

outperformed whilst bottom quartile

companies consistently underperformed

– including holdout year