My students learn that I’m a big fan of Economic Value Added (EVA) as a profitability. A new measure — called EVA Momentum — takes EVA a step further. Worth watching.
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Excerpted from Fortune: Value Driven – A new financial checkup, January 11, 2010
ROE? Gross margin? Earnings per share? It’s easy to make any of them look better while damaging the business.
Enter EVA. Economic Value Added is essentially profit after deducting an appropriate charge for all the capital in the business. Because it accounts for all capital costs, EVA is the best measure of value creation.
A new ratio — EVA momentum — takes EVA to the next level by being difficult to manipulate.
“It always increases when managers do things that make economic sense.”
EVA momentum is a simple concept: It’s the change in a business’s EVA divided by the prior period’s sales.
So if a company increases its EVA by $10 million and the prior period’s sales were $1 billion, then its EVA momentum is 1%.
For most companies, EVA momentum is zero or negative, and the average for many companies is generally around zero.
Stewart’s firm, EVA Dimensions, has crunched the five-year data for firms with revenues of at least $1 billion. The three top performers by EVA momentum: Gilead Sciences (with an average annual EVA momentum of 24.3%), Google (22.7%), and Apple (12.1%).
Achieving high EVA momentum requires a business to do two difficult things at once. It must grow while at the same time maintaining healthy EVA profit margins or improving poor ones.
While Stern-Stewart (fathers of EVA) have measured EVA momentum in hundreds of companies, real businesses have yet to apply it.
So there’s no telling what will happen when this ratio confronts actual managers trying to make actual profits.
But, it’s a new idea that just might work.
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EVA momentum: How to get it right
- Don’t obsess about sales. Managers fixate on how to increase their company’s revenues, but if it doesn’t boost EVA, it does nothing to create value.
- Bail out of EVA-negative businesses. Ford’s sale of capital-intensive, EVA-sapping Jaguar and Land Rover shrank the company, but in the end increased its value.
- Annihilate wasted capital. Cutting working capital, as Wal-Mart did in 2009, and offloading unproductive assets are great opportunities to build EVA when growth is slow.
Full article:
http://money.cnn.com/2010/01/08/news/economy/eva_momentum.fortune/index.htm
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