What’s common between Reliance, Airtel, and JSW Steel? These gigantic businesses have family owned roots. Often such businesses are looked down upon due to the ‘family’ being in control, but performance wise such enterprises may be better. Yes, in terms of market performance. The ‘Credit Suisse Family 1000 in 2018’ report, published by the Credit Suisse Research Institute (CSRI), reveals that family-owned businesses outperform broader equity markets across every region and sector on a long-term basis.
Family-owned businesses deliver stronger revenue growth in all regions and higher levels of profitability, which in turn supports the relatively strong share price appreciation seen since 2006. In 2017 alone, Non-Japan-Asia-based family-owned companies generated 25.63% greater cash flow return on investment (CFROI) than their non-family owned counterparts and delivered a 4.2% outperformance in annual average share price return since 2006.
The CSRI analysed its database of over 1,000 family-owned, publicly-listed companies, ranging in size, sector, and region, looking at their performance over 10 years compared to the financial and share price performance of a control group consisting of more than 7,000 non-family owned companies globally.
The study covered 11 markets in the Non-Japan Asian region, which continue to dominate and represent a 53% share of the universe, with a total market capitalization of over $4 trillion.
With a total of 111 companies and $839 billion total market capitalization, India continues to rank #3 globally in terms of the number of family-owned companies, followed closely after China (159 companies) and the US (121 companies).
Within the region, China, India, and Hong Kong dominate. These three jurisdictions combined comprise some 65% of the Non-Japan Asian section of the CSRI’s database, with a combined market capitalization of $2.85 trillion (or 71%) of the market share of the Asian universe. Korea came in fourth place, with 43 companies ($434.1 billion market capitalisation), followed by Indonesia, Malaysia, the Philippines and Thailand, each with 26 companies.
All in the family
Eugène Klerk, head analyst of thematic investments at Credit Suisse and the report’s lead author, said: “This year we find family-owned businesses are continuing to outperform their peers in every region, every sector, whatever their size.”
Klerk thinks the outperformance is on the account of the longer-term outlook of family-owned businesses relying less on external funding and investing more in research and development.
Family-owned companies with special voting right structures perform relatively in line with those with ordinary shares, contrary to the fears expressed by many investors. This has implications for investors.
There are many important conclusions.
1. Family-run businesses boast superior growth and profitability – The financial performance of family-owned companies is superior to that of non-family-owned businesses. Revenue growth is stronger, earnings before interest, tax, depreciation, and amortization (EBITDA) margins are higher, cash flow returns are better and gearing is lower.
2. Indian parivar rocks – Family-owned companies in India generated a 13.9% annual average share price return since 2006, compared to 6.0% recorded by their non-family-owned peers. In terms of sector contributions to total market capitalization, Tech (18%), Consumer Discretionary (16%) and Materials (15%) make up the top three sectors.
3. Small is sweet – In the Non-Japan Asia region, small-cap companies, with a market capitalization of less than $3 billion, took up 54% of the universe of family-owned businesses, while 42% of the family-owned companies in Europe and 45% in North America have a market cap of $7 billion or more. This could be due to the younger age of firms. Companies in emerging countries such as Non-Japan Asia and Latin America tend to be younger. Over 80% of the Non-Japan Asian family or founder-owned companies in the database are of first and second generation.
One of the main reasons many investors stay away from family-owned businesses is due to the perception of families exerting undue influence, which ultimately may hurt returns.
When reviewing total shareholder returns of family-owned businesses with ordinary shares versus those with special voting rights, the difference was negligible, indicating that investor concerns in this area are misplaced.
Succession risk, for example, may be overstated. The Credit Suisse report showed that first and second generation family-owned companies generated higher risk-adjusted returns than older peers during the past 10 years.
The report does not see this to be due to succession related challenges but a reflection of business maturity. The report illustrates that younger family-owned companies tend to be small-cap growth stocks, which has been a strong performing style whereas older firms are less likely to be located in the “new” more disruptive (i.e. technology) sectors, which by their nature offer much stronger growth.