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Diminishing Returns

Authorized ROEs shrink over time.

Fortnightly Magazine - September 2008

This year’s Fortnightly 40 survey showed that while F40 companies have grown their average return on equity (ROE) in the past three years, those returns have grown slowly compared to some other measures—including appreciation in share prices.

Of course, share prices might be expected to fluctuate more than ROE figures do, since a company’s stock is subject to short-term trading trends that have only secondary effects on ROE. And the F40’s two-year rise in average ROE—128 basis points—is really nothing to sneeze at.

Nevertheless, anecdotal evidence suggests the industry’s ROE is straining under increasing pressure. Regulated returns, in particular, face intense public scrutiny as commodity prices and infrastructure costs increase.

Wondering whether industry statistics would bear out this observation, we turned to the Fortnightly.com ROE Database—a new feature on our website, www.fortnightly.com, which contains facts and figures for nearly 600 rate cases going back to 1996. The results show a clear trend (see Figure 1) . Despite a broad standard deviation, average authorized ROE rates have declined steadily over the past 12 years.

Whether this decline tracks the industry’s risk profile depends on one’s perspective. Things like revenue decoupling and pre-approval for capital spending are reducing companies’ risk exposures. But to the degree the utility business is becoming more uncertain and complex, regulated ROE is going in the wrong direction.