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.
Sara Mathew of Dun & Bradstreet enters the WCI ranking at No. 1 this year, not bad for someone who only became CEO in January 2010 and first became eligible this year. Having previously served in various executive positions, such as president, COO and CFO, the former P&G executive has carefully guided the 171-year-old provider of business data and risk-management services at a time when the company continues to be challenged to revive business growth.
Last year, it failed to find a buyer for the company; but in its favor, D&B has an astute business design, anchored by the enduring demand for information businesses must have: customers’ creditworthiness and in-depth sales-lead characterizations. In the U.S., D&B is the definitive source of both. And the investment required to recreate its information serves as a barrier to entry, which protects D&B’s pricing. Nicely profitable (EBT 20 percent-plus over the past three years) and well-managed, D&B employs (lower-profit) partnering to grow internationally. Earlier this year, Mathew announced that she will retire by May of 2014.
Gilead Sciences, Monsanto, Sherwin-Williams and Fastenal, all of whom are in the top five, are repeat performers over recent years, showing that as value creators, their CEOs have the discipline and staying power to manage resourcefully through good times and bad. Interestingly, the CEOs of Monsanto, along with Yum! Brands and Honeywell are each recent honorees of the Chief Executive of the Year award and are among this year’s top 100 wealth creators.
A number of firms shot up in the ranking this year, improving their scores across the board. These include the independent exploration and production company Cabot Oil & Gas, which is riding the natural gas boom. (In a recent presentation to investors, Cabot said it produced about 268 billion cubic feet of natural gas equivalent, a record despite recent lower prices for Marcellus shale natural gas.)
Others get their boost from being able to sustain value-producing niches. Jumping to 13 in the ranking this year is Ecolab, a global leader in water, hygiene and energy technologies and services that protect people and vital resources. With 2012 sales of $12 billion and 44,000 employees, the company delivers comprehensive solutions and on-site service to promote safe food, maintain clean environments, optimize water and energy use and improve operational efficiencies for customers in the food, healthcare, energy, hospitality and industrial markets in more than 170 countries around the world. Ecolab’s three-year economic margin is only rated at a B level, but their management quality is a solid A.
The fundamentals of wealth creation are not confined to these public companies. Privately held firms can apply the principles outlined here regardless of structure or ownership status. Create a unique and long-lasting competitive position, differentiate your offerings and deliver value. Of course, it never hurts to be in businesses that have low capital requirements, which allow for faster re-investment of profits. But even capital-intensive businesses like Monsanto’s agri-science and Honeywell’s aviation and defense technologies show that one can invest for the future and still show stellar results today.
Chief Executive Group exists to improve the performance of U.S. CEOs, senior executives and public-company directors, helping you grow your companies, build your communities and strengthen society. Learn more at chiefexecutivegroup.com.
0
1:00 - 5:00 pm
Over 70% of Executives Surveyed Agree: Many Strategic Planning Efforts Lack Systematic Approach Tips for Enhancing Your Strategic Planning Process
Executives expressed frustration with their current strategic planning process. Issues include:
Steve Rutan and Denise Harrison have put together an afternoon workshop that will provide the tools you need to address these concerns. They have worked with hundreds of executives to develop a systematic approach that will enable your team to make better decisions during strategic planning. Steve and Denise will walk you through exercises for prioritizing your lists and steps that will reset and reinvigorate your process. This will be a hands-on workshop that will enable you to think about your business as you use the tools that are being presented. If you are ready for a Strategic Planning tune-up, select this workshop in your registration form. The additional fee of $695 will be added to your total.
2:00 - 5:00 pm
Female leaders face the same issues all leaders do, but they often face additional challenges too. In this peer session, we will facilitate a discussion of best practices and how to overcome common barriers to help women leaders be more effective within and outside their organizations.
Limited space available.
10:30 - 5:00 pm
General’s Retreat at Hermitage Golf Course
Sponsored by UBS
General’s Retreat, built in 1986 with architect Gary Roger Baird, has been voted the “Best Golf Course in Nashville” and is a “must play” when visiting the Nashville, Tennessee area. With the beautiful setting along the Cumberland River, golfers of all capabilities will thoroughly enjoy the golf, scenery and hospitality.
The golf outing fee includes transportation to and from the hotel, greens/cart fees, use of practice facilities, and boxed lunch. The bus will leave the hotel at 10:30 am for a noon shotgun start and return to the hotel after the cocktail reception following the completion of the round.
