Last January I wrote an article about the importance of the return on equity (ROE). At the time, the reporting season had not commenced and therefore the figures quoted were based on the 2012 financials with the exception of Bank of Valletta, Maltapost and Crimsonwing (three companies whose financial year does not end in December).

I had concluded the article by stating that the ROE league table should be revisited once the 2013 financial statements were published. With all companies having now published their 2013 results, it is possible to update and compare the league table with the figures presented in January.

A number of changes were expected due to the one-off nature of certain transactions that positively impacted the 2012 financial performance of a number of companies. In fact, the company with the highest ROE in 2012 was Grand Harbour Marina at 37.6 per cent.

As anticipated last January, this return declined significantly in 2013 and GHM does not feature in the updated table with those companies which have a double-digit ROE. GHM’s high return in 2012 materialised as a result of the 2012 sale of a superyacht berth. No berths were sold in 2013 and the company’s performance was much weaker as a result.

Go also experienced an expected decline in its ROE. The 2012 ROE of 18.7 per cent was boosted by the gain registered from the exchange of properties with the government of Malta. Since this was a one-off exceptional item and did not form part of the core business of the group, the financial performance during 2013 declined and the ROE dropped to 11.5 per cent.

In the banking sector, the ROEs also declined as the banks suffered a decline in earnings due to the low interest rate environment and increased regulation. The ROE of HSBC Bank Malta declined from 16.1 per cent in 2012 to 14.3 per cent. This is exactly in line with the ratio of Bank of Valletta plc at 14.4 per cent for the year ended September 30, 2013. Since BOV’s interim financial results to March 31, 2014, published a few weeks ago showed a 22 per cent decline in profits, the ROE for BOV’s current financial year should also be on a decline. Likewise, the ROE of Lombard Bank Malta dropped from 7.5 per cent in 2012 to only 5.2 per cent in 2013 largely impacted by the higher level of impairments that were required.

The three firms in the IT sector all feature in the league table of companies with double-digit returns. The 24.7 per cent figure for Crimsonwing published last January relates to the financial year ended March 31, 2013. Crimsonwing will be publishing its 2013/14 financial statements in the coming weeks and the ROE is expected to improve given the performance at the half-year stage (+28 per cent in net profits) and the further guidance provided by the company’s directors last February. In the interim statement, Crimsonwing’s directors stated that group revenue for the nine months ended December 31, 2013, amounted to €15.56 million, representing a 16 per cent increase over the previous comparable period. The directors noted that Crimsonwing’s second half performance will be broadly similar to that registered in the first half with revenue expected to exceed the €20 million level during the year ended March 31, 2014.

The ROE is a widely used indicator by financial analysts worldwide to gauge a company’s performance. However, this should not be the only ration used

The ROE of RS2 Software plc only improved marginally from 13.8 per cent in 2012 to 14.4 per cent in 2013 despite the 18 per cent jump in profitability to a record level of €2.9 million. Similarly, the ROE of 6pm Holdings increased to 14.1 per cent in 2013 from 10.2 per cent in 2012 also as a result of the improved performance by the company. However, the returns of RS2 Software are not comparable to those of Crimsonwing and 6pm since their business models and financial structures are different although all three operate in the IT sector. As an example, RS2’s total amount of equity at €21.5 million is significantly above the equity base of the other two smaller companies given RS2’s investment in their head office and their Bankworks system which collectively are valued at over €15 million in the financial statements.

Crimsonwing currently leads the table with the highest ROE. The second-highest ROE is that of Malta International Airport plc. MIA’s return improved from 20.5 per cent in 2012 to 22.6 per cent in 2013 following another record financial performance. MIA has been among the most consistent performers in recent years with a steady increase in profits as the company benefited from the record number of passengers using the airport terminal. This boosted the ROE from 16.6 per cent in 2008 to 22.6 per cent in the last financial year and helped the company’s share price to reach new highs. The significant improvement in returns was not only as a result of the high number of passengers using the airport but also a reflection of the strategic investments undertaken in recent years by the company. The air terminal extension greatly enhanced the company’s overall revenue and the benefits of the more recent investment in the Sky Parks Business Centre should help to enhance shareholder returns in 2014 and beyond.

Although other companies do not feature in the league table with double-digit returns, they are still worth mentioning given their different characteristics. Medserv plc returned to a profitable position in 2013 as the company started to benefit from increased business in the Mediterranean region. Medserv’s ROE for 2013 was 5 per cent. Due to the recent debt issuance programme, Medserv was obliged to publish financial forecasts and the company anticipates a significant improvement in profits due to the commencement of a number of important contracts with international oil companies in Malta as well as in Cyprus. This should help the ROE to rise to 8.4 per cent in 2014.

The ROE of Simonds Farsons Cisk is not a good indicator to gauge the profitability of the core business due to the large property portfolio owned by the group which is not generating any returns. In fact, the ROE at 6.8 per cent is low but this would be best analysed using only the asset base of the core business rather than the entire group. Such an analysis would be possible if Farsons proceeds with its plans to obtain a separate listing of the property company. This would enable investors to analyse the core operations of Farsons independently of the property portfolio.

Other property companies also have lower returns given the nature of their business which is very capital intensive. However, the ROE of Malita Investments plc at 10.2 per cent is attractive given its business profile.

The ROE is a widely used indicator by financial analysts worldwide to gauge a company’s performance. However, this should not be the only ratio used. Other indicators include the dividend yield and the price to earnings ratio. Next week’s article in The Business Observer will deal with the dividend yield. However, as I explained last January, while the historical returns and trends are important considerations before taking an investment decision, the expected future returns are naturally of greater importance for equity investors. As such, management of public companies should therefore do their utmost to guide the market accordingly on future expectations.

Rizzo, Farrugia & Co. (Stockbrokers) Ltd, (RFC), is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.

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Edward Rizzo is a director at Rizzo, Farrugia & Co. (Stockbrokers) Ltd.