Having an Out-of-Money Experience
October 13 2009 by JP Donlon
The fact that, at this writing late in the third quarter, stocks have risen sharply—by some estimates up 50 percent from their March 2009 lows—does not obscure the fact that we’ve witnessed an extraordinary level of wealth destruction. Reuters’ Joe Rauch reports that the recession—now in its 22nd month—triggered the first worldwide contraction in assets under management in nearly a decade. A Boston Consulting Group study found that wealth dropped 11.7 percent to $92.4 trillion. The BCG report indicates that a return to a 2007 level of wealth will take six years.
This puts into perspective our second annual Wealth Creation Index (WCI), where we size up the value creation performance of CEOs of S&P 500 companies over a three-year period see 2009 CEO Wealth Creators and Destroyers. The analysis relies principally on the concept of Economic Margin (EM—operating cash flow minus an appropriate capital charge divided by invested capital) to get at the true economic wealth management has created for its shareholders. Once upon a time, CEOs would grow earnings or earnings per share in the belief that the share price would rise in response. Those days are as quaint as Mouseketeer reruns on the Disney Channel. Investors—principally institutions but also private equity—now look at the underlying economic reality. So if the real world judges CEO performance by measures that seek to get at this underlying reality it’s best if CEOs see themselves as others see them.
There are many metrics used to measure real value creation. Some, like earnings per share (EPS), are practically useless for managing a company. There is no silver bullet metric to measure wealth creation but until perfect comes along EM comes closer than most. We are appreciative of the efforts of the Applied Finance Group team, led by Mike Burdi, and to Drew Morris of Great Numbers LLC in analyzing the data in the WCI.
Our purpose in presenting the WCI is to give CEOs a clean, workable standard by which one can measure one’s performance against other public companies as well as against one’s earlier performance. You need not be publicly traded to do this. These days, there is a private equity premium and when the time comes to sell or go public measures such as this will help. For a more detailed exploration of what’s possible, see “Leading Your Business to Maximum Results”