Too many wondering days!! I come with another piece of article explaining you an important thing, which most of the people do not understand, or even if they understand, do not act or rather procrastinate! And that very thing is “Opportunity Cost”.

I always have this in mind, why do people run telecom business? And why to run even textiles business? And, why everyone does not get into business of Pharmaceutical or Chemicals? The difference in rate of returns which these industries earn are huge. And hence, one should obviously, consider to start business which has higher returns on their investments.

So, I picked up these 4 industries mentioned above, and took out one company from each of these industries to find out what returns on an average these companies earn. I have tried to find out returns earned by these companies for past two years i.e. 2017-18 and 2018-19. Also, the data i.e. Total Equity and PAT is directly taken from www.screener.in, these data are verified/adjusted after comparing with their respective annual reports.

Return on Equity (ROE) was considered as it represents how much amount Shareholders of the companies take home. I.e. In short, if you have invested Rs. 50 Cr. of your own money i.e. Total Equity, what will be the returns after deducting all expenses, interest and taxes i.e. Profit after Tax or PAT.

People/Investors might argue the use of this returns ratio which I have considered i.e. ROE. This is my personal opinion to calculate the returns earned by businessman if they were to invest money. Some might take ROCE or even ROIC. My purpose of taking this ratio is to calculate how much % of return an individual will take home on his own money (ROE), and not overall returns earned by the business (ROCE, ROIC). The result of the average returns of past 2 years generated for each companies (namely Bharti Airtel, Raymond, NOCIL and Torrent Pharma) are shown below:

Hence, it is noticed that, average 2 years returns of Telecom and Textile’s possibly best companies in industry earns ROE of less than 8.5% (nearly F.D Rate). And average 2 years’ ROE’s of Chemical and Pharma’s average companies in industry has ROE of at least 11.5%. (If we take best companies in these industries, we see ROE of as high as 25% to 30%).

So, what do we learn? Fixed Deposit rate in India is around 6-8%. So, if one has to put in efforts, run a company, work for 10 hours a day, sacrifice many things, just to earn less than 6-8% ROE, then what is the point? You might simply relax, sit home, enjoy life and still earn 7% by putting all your money in Bank as F.D.

This is what I say as Opportunity Cost. Opportunity Cost defined by www.investopedia.com as “Opportunity costs represent the benefits an individual, investor or business misses out on when choosing one alternative over another.”

Hence, if business is earning ROE of 6-8%, there is alternative i.e. opportunity cost of putting money in F.D to earn similar returns and relax. We have to select the best alternative to earn maximum return. For some reason or the other like, future expectations in business, sticking to same business over years, and personal reasons, etc. people just keep running these businesses even if it does not produce near F.D returns. When you find historical averages for ROE’s, it will still suggest that business of these industries are not profitable, people out of habit continue to do these kinds of business.

But, is it not unfair? To compare a risk free F.D return with risky nature of business? Hence, to compare apples to apples, I have taken out Historical Returns of ETF NIFTYBEES so the risky returns of Nifty can be made more comparable with Business returns. NIFTYBEES was selected considering its liquidity so that the returns can be calculated on actual basis if we were to invest money in it. Analysis of same is given below:

NIFTYBEES is trading since Jan 2002, hence returns from inception is calculated. 1 Year Return is Simple Average whereas 3/5/7/10 Years return are CAGR.

“I have shared a google drive link for all my excel calculations at the end of this article”

Hence, what we understand from the above exercise is that, even if we take long 10 years horizon, Nifty has given us minimum return of at least 12.50%.

I dive in a bit further deep, and tried to adjust this 12.50% average returns for transaction cost and taxes. Because, when business’s ROE is calculated, PAT is considered which is after deducting all the taxes. Hence, another snapshot of Net Average returns after deducting all the costs and taxes:

Hence, it is clear, that if you are into a risky venture of earning money, you should at least earn ROE of 10.5%. And this 10.5% is your opportunity cost. So, if your business is not even generating this bare minimum return of 10.5%, then the best choice one would have is to again sit, relax, enjoy life and invest in NIFTYBEES to earn average return of 10.5%.

CONCLUSION and DISCLAIMER:

In Future, whatever business you start. Whatever venture, partnership, etc. you fall into, anywhere you invest your money. Make sure that you earn at least bare minimum return of 10.5%. Because, after putting in all of efforts, if you are not able to earn this bare minimum rate of return, you have wasted your time. The better alternative is to just invest in NIFTYBEES which will give you return of 10.5% at least, on an average over 10 year. Hence, 10.5% can be considered as your “Opportunity Cost of Capital”.

I have conducted all my calculations in a excel sheet. The google drive link to download the sheet is: Click Here

1. I have considered ROE as correct proxy for calculating returns. Some might argue that ROCE, ROIC or etc. are best alternative. I suggest, you should conduct your own analysis to find out what is the best way. My purpose of taking ROE is just on pure basis of how much businessman will earn in return %, if they invest the amount.
2. This is just a personal opinion regarding opportunity cost, it might vary from person to person.
3. Do review my excel sheet. Do comment for any queries or suggestion.

Thanks!!!