Brief Articles About Best Practice EVA, Management and Markets

How to Measure Earnings for Long Term Value

What would you think about a company whose reported earnings per share tumbled from a peak near $2.50 to a 33-cent loss over five years, whose operating margin and ROI collapsed, and where cash flow from operations was so negative that the company had to import boatloads of capital?  Oh, and toss in 11 straight quarters of earnings misses and “guide-downs” about future results for good measure.

Investors must have pummeled the stock, right?  Wrong.  The company is Amazon, and it was a top performer among large-cap U.S. stocks, soaring from $73 a share to well over $300 over the five years.  Scrambling to explain the Amazon “anomaly,” market pundits claim Amazon enjoys a unique status as a “story stock”—one where investors are singularly patient about and trusting in the visionary strategy of CEO Jeff Bezos and his team.

But that’s just not the reason.  The popular explanations miss the correct one—namely, that short-term earnings and related bookkeeping metrics simply are not what investors use to set stock prices.

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The Statistics of Wealth Creation

Two financial metrics elegantly summarize the overall performance and value added of a business.  Both are based on the EVA measure of economic profit.  Taken together, the metrics give the top team and board of directors a reliable bird’s eye view of how well the firm is doing, and how well the distinct lines of business are performing, too.  The metrics are far better than old standbys like EPS growth, profit margin, ROI or cash flow. 

EVA Dimensions updates the 20-year history of the metrics for over 10,000 companies the world over each day.  It is now possible to benchmark the EVA metrics for any one company against public peers, and to use the percentile standing in grading incentive pay plans that are tightly aligned with total shareholder returns.  In short, EVA is no longer just a money measure of economic profit, personal to each company.  EVA is now a full-fledged statistic that can and should replace other financial metrics in the business lexicon. 

Ideally, the metrics should be compared with a group of at least 20 companies that are operating in the same or similar business lines.  In this memo, though, we will furnish insights into the typical results generated across the entire Russell 3000 companies.  This is more relevant than you may think.  The EVA metrics are so effective at neutralizing business model differences they make close cousins of even distant relatives.

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EVA Helps Privately-Owned Barry-Wehmiller Drive Profitable Growth

EVA, for economic value added, has helped the Barry-Wehmiller Companies, a family-owned maker of capital equipment, to rise to the ranks of the most successful corporate acquirers over the past quarter century.

EVA has also featured in a stock purchase plan that enabled key employees to share in the wealth they are creating while motivating them to create even more.

Since 1998, the company’s sales ballooned from $38 million to $1.4 billion, with the bulk from 63 acquisitions.  But Barry-Wehmiller has not just gotten bigger.  Using the discipline of EVA to temper purchase prices and to integrate acquired companies under a common financial umbrella, Barry-Wehmiller produced stunning financial results.

Its EVA—which measures profit net of a full capital charge, including a priority return for the shareholders—increased mightily, and was behind a 16% compound annual increase in the firm’s appraised share value since 1998. $1 in company value then became $9.34 today, with a 3% dividend yield to boot.

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What Really Determines TSR?

Linking pay to performance is one thing.  Driving performance, another.  

The real challenge directors face is how to motivate managers to make the decisions that will actually produce the greatest total shareholder return – or TSR – over time. 

Ironically, TSR isn’t the answer.  TSR itself says nothing about how to increase TSR, and it can’t be measured for business lines or specific decisions.  Hitching pay to TSR is also a great mistake because a far better answer now exists.

The breakthrough we have achieved is to draw a straight line from TSR to the underlying corporate financial measures that any management team can use to manage the business and maximize the shareholders’ return.

Now you can have your cake and eat it, too.  Now you can tightly align incentive pay to TSR performance, and you can have the management team clearly aiming at the decisions that will drive shareholder value. 

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Introducing Best Practice EVA

Health elixirs and fountains of youth are the stuff of fantasy.   But here is a claim you can bank.

Put your company on a strict diet of the best practices in EVA, and you’ll see muscle replace fat, and you’ll add speed and agility that can make a huge difference in how your company performs.

The quality of decisions will sharpen, plans will become more strategic, capital conscientiousness will take root, teamwork will spread, and a resolute commitment to achieve real operational improvements and innovative and profitable growth will become all pervasive.

In short, you’ll set the stage for generating a far higher shareholder return and growing a healthier, more robust company that is a more rewarding place to work.

It comes down to this: Make increases in real economic profit, or what I call EVA, for economic value added, your most important financial goal and decision rule.  Use it for setting goals, grading and improving plans, measuring decisions, and motivating the team with bonus pay.

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