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Creation and Measurement of Shareholder Value

Creation and Measurement of Shareholder Value. by Carlos De Mello e Souza. question. Question: What is the executive’s job?. Friedman.

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Creation and Measurement of Shareholder Value

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  1. Creation and Measurement of Shareholder Value by Carlos De Mello e Souza

  2. question Question: What is the executive’s job?

  3. Friedman There is one, and only one responsibility of business - to use its resources and engage in activities designed to increase its profits as long as it stays within the rules of the game. ~ Milton Friedman, 1976 Nobel laureate in Economics ~

  4. toc Creation and measurement of shareholder value: • Value: the goal of management • Value measurement • Value drivers • Value drains • Cases and examples

  5. goal? Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases What is the goal of management?

  6. possible goals Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases What is the goal of management? • max total market value; or... • satisfy all with a stake in the firm; or... • max total market value subject to keeping stakeholders satisfied Market value = debt + equity (financial claims) Stakeholders: employees, government, community, customers

  7. measurement options Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases Measuring value • Method 1: discounted free cash flows (FCF) • Method 2: discounted residual net operating earnings (NOI)

  8. measure with cash flows Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases > cash flows Measuring value • Method 1: discounted free cash flows Note:

  9. measure with earnings Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases > residual earnings Measuring value • Method 2: residual NOI (aka EVA) Note:

  10. measurement: which method? Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases > comparison of two methods Measuring value • Which method is best? • Cash distributed is true source of value • Both methods must produce same value • Using both helps to find errors • REM uses familiar accounting measures • Easier to design improvement strategy based on REM

  11. drivers Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases Value drivers: • ROA (“return on assets”) • growth

  12. drivers ROE ROA leverage pm ato D/SE spread ROA cogs surplus - rd sg&a NWK tax, etc... NLTA Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases > ROE Value drivers: + x x

  13. drivers Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases > growth Value drivers: growth • research & development • advertising; brand image; customer service & loyalty • cost advantages in: production, selling, procurement, distribution, raising capital • leadership & strategic positioning

  14. drains Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases Value drains • misalignment of goals of managers/owners (inadequate incentives) • poor governance infrastructure • leadership problems • poor quality of disclosures to investors • significant unproductive assets

  15. cases Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases Cases

  16. case 1: XOM Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases > XOM Exxon Mobil2004 roe 29 roa 26.9 lev 2.1 pm 9.6 ato 2.8 x d/se .09 spr 22.2 cogs 47.8 cx 19.5 dd sg&a 4.8 wk 1.2 dd other 37.8 lta 111 dd

  17. case 2: CVX Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases > CVX Chevron2004 roe 33 roa 25.8 lev 6.9 pm 8.8 ato 2.9 x d/se .29 spr 23.6 cogs 60.8 cx 17.2 dd sg&a 2.9 wk 1.1 dd other 27.8 lta 106 dd

  18. case 3: GOOG Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases > GOOG Google2004 roe 23 roa 23 lev -- pm 12.6 ato 1.8 x d/se -- spr -- cogs 43.7 cx 82 dd sg&a 17.2 wk 70 dd other 26.5 lta 50 dd

  19. price chart WMT Wal Mart 1974-1984

  20. price chart WMT Wal Mart 1984-1994

  21. price chart WMT Wal Mart 1994-2005

  22. price chart IBM IBM 1974-1984

  23. price chart IBM IBM 1984-1994

  24. price chart IBM IBM 1994-2005

  25. price chart XOM Exxon Mobil 1994-2005

  26. price chart YHOO Yahoo 1996-2005

  27. price chart GOOG Google 2004-2005

  28. case for class discussion Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases Case for class discussion • dupont analysis:What is happening with ROE, ROA, pm, ato? Why? • definition of EVA: Calculate EVA in 2003 and 2004 assuming that wacc=7.8% • assumptions for the future: (using valuation model) What fair value at 01/01/2004? • Handouts: 1999-2003 financials & dupont ratios

  29. case 4: SK Creation and measurement of shareholder value: goal, measurement, drivers, drains, cases > SK SK2004 roe .3 roa 2.8 lev (2.5) pm 2.2 ato 1.3 x d/se 1.1 spr (2.2) cogs 84 cx 14 dd sg&a 8 wk 33 dd other 5.8 lta 243 dd

  30. Fisher Stocks have reached what looks like a permanently high plateau. ~ Irving Fisher, in 1929 ~

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