CEO Value Maximizers Including Dun & Bradstreet Corp. (NYSE:DNB) & Gilead Sciences (NASDAQ:GILD)
The following is an excerpt from our most recent annual ranking of CEO’s within the S&P 500 based on Management’s understanding and execution of creating and maximizing value. To view the original article on ChiefExecutive.net click here.
Everyone talks about shareholder value, but markets and managements tend to talk past each other in terms of what true value really is. There needs to be a shared vocabulary and a set of common standards upon which everyone can agree.
Traditional accounting-based valuation methods provide an incomplete view of a company’s value by not accounting for investment to generate the earnings, cost of capital, inflation or cash flow. The Wealth Creation Index (WCI) created in partnership with Applied Finance Group (AFG), a global performance advisory and equity research firm, and Drew Morris of Great Numbers!, seeks to identify real value—as opposed to Generally Accepted Accounting Principles (GAAP) value.
AFG uses a proprietary framework it calls Economic Margin (EM) to evaluate corporate performance from an economic cash flow perspective that is an alternative to accounting-based valuation metrics. EM measures the return a company earns above or below its cost of capital and, thus, provides a more complete view of a company’s underlying economic vitality.
The core of AFG’s framework is the conviction that accurate valuations require understanding how well a firm has used its invested capital. Currently, common measures of corporate performance are based on earnings, such as earnings growth, price to earnings and Return on Equity (ROE). Accordingly, firms will often undertake actions that increase earnings (and taxes)—but that do not create value—in the hope of inducing stock analysts’ upgrades. Many argue that importance placed on the role of earnings is misplaced because earnings are only a part of the shareholder wealth-creation process. EM corrects these accounting distortions by taking into account asset life, asset mix, asset age, capital structure and growth, effectively linking the income statement and balance sheet. EM levels have a much higher correlation with market values.
EM measures the degree to which companies are making money and growing the underlying business over and above its risk-adjusted cost of capital. It’s expressed as a percentage of productive capital and calculated as operating cash flow minus a capital charge—all divided by invested capital. Companies with positive EM—greater than zero—are creating wealth; those with negative EM are destroying it.
There is no single, unified measure that will serve every business leader’s metric. After coming up with the Theory of Relativity, Einstein spent his remaining years searching for a unified field theory that would explain all the known laws of the universe—and he came up empty. So until something like that happens in economic finance, EM comes as close as any business owner can hope in reckoning how every business dollar invested in the business is working.
Link to Entire Article on ChiefExecutive.net
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