11 Feb Assessing the Value of Value: Looking at True Corporate Value Drivers
Some would argue that the primary role of a business is to create and return value to its shareholders. While organizations can and should create ever-increasing value for owners, above the cost of capital, there are the naysayers that vilify corporations at the expense of those who own them and work in them. A healthy balance between these two philosophies can and must exist. Value creation is much more than simply returning cash profits to shareholders. The higher road, which includes things like Corporate Social Responsibility (CSR) and other soft metrics are becoming more demanded by conscious consumers. Many would liken the old profitability metric to a bodybuilder solely focused on his arms or chest while ignoring other key components that make him a truly sculpted and balanced specimen. The new definition of corporate profits helps round-out the company into something that has a net benefit to all, not just those that hold the shares.
The two chief drivers in value assessment is couched in the following:
The company should create regular, on-going value for shareholders, typical in the form of profits (and by default, dividends)
The company should increase the total value of the enterprise, which could include value returns to other “stakeholders” like customers, the environment, the world, etc.
Long term value assessment tends to increase welfare to shareholders and employees. Customer satisfaction typically increases and companies focused on long-term sustainable growth tend behave more responsibly. There are also certainly areas where a focus on short-term results can hamper long-term sustainability and put shareholders, customers, employees and the general public at risk of detriment. A focus on the near-term can not only hurt the company, but can lead to greater macro-related issues, including market bubbles. Long term value enhancement (by definition) is had in returning cash flows to shareholders at rates higher than the cost of capital. A company that does this typically has a competitive advantage over competitors.
The following focal points help gauge the role of short vs. long-term value creation:
Is there an overemphasis on earnings per share (EPS) and other short term financial metrics? Put differently, is there an emphasis to try to create value by simply changing the capital structure or an accounting practice?
Is research and development (R&D) expense a regular cost and a primary focus of the business or does it simply represent a cut-able “cost” center?
Are other short term costs available for cutting that may have long-term profitability impacts?
Is the company financing illiquid assets with short-term debt? Of the handful of financial crises arising over the last 30 years many can be largely attributed to this type of financial engineering activity.
Is there a focus on getting bigger (the driver for many of today’s firms) without maintaining a true competitive advantage?
Is there premature desire to extract value too early, like in the case of a dividend recap?
I read a study sometime ago that corroborated data from both Europe and the United States, showing a direct and significant correlation between value creation and employment. Value is not created by securitization (e.g. risky home loans), financial engineering or in looking at the wrong metrics. The greatest corollary to sustainable long-term value within an organization is in the company’s seeking and fully exploiting new areas of competitive advantage. There is no evidence that a link exists between the value created by the acquisition of another company and Earnings Per Share (EPS) even exists.