Week 1 Flashcards
Value is a particularly helpful measure of performance because
takes into account the long-term interests of all the stakeholders in a company, not just the shareholders
why is value relevant to all shareholders
companies that maximize value for their shareholders in the LONG TERM also create more employment, treat their current and former employees better, give their customers more satisfaction, and shoul- der a greater burden of corporate responsibility than more shortsighted rivals.
Benefits of long term perspective of value creation on the economy
more robust and build stronger economies, create more jobs, greater commitment to meeting their social responsibilities
- coporate social responsibility initiatives that companies take can help them create shareholder value
value creation
companies create value by investing capital they raise from investors to generate future cash flows at rates of return exceeding the cost of capital i.e. operation generates higher return than cost of capital
what drive value
combo of ROIC, growth relative to its cost of capital
conservation of value
Anything that does not create cash flow does not create value unless it reduces the risk.
example of conservation of value
- when a company substitutes debt for equity or issues debt to repurchase shares, it changes the ownership of claims to its cash flows. However, it doesn’t change the total available cash flows – value is conserved, not created
- changing accounting techniques will change the appearance of cash flows without actually changing the cash flows
Why is creating sustainable value a long term endeavour
in the long term, competitive with drive down competitive adv and ROIC
long term perspective of value creation
What must managers do?
managers must resist short- term pressure to take actions that create illusory value quickly at the expense of the real thing in the long term
long-term perspective on value creation
what correlation is there
strong positive correlation between long-term shareholder returns and investments in R&D
- companies with the highest total returns to shareholders (TRS) also had the largest increases in employment.
- companies that earned the highest shareholder returns also invested the most in R&D.
the amount of value a company creates is governed ultimately by
its ROIC, revenue growth, and of course its ability to sustain both over time.
focusing too much on earnings or earnings growth often leads
leads companies to stray from a value-creating path.
Disaggregating cash flow into ____
Cash flow increase may come from
revenue growth or investment reduction, or cost reduction
Growth opportunity ‐‐ Additional value is created if
the company can invest in new projects earning above the cost of capital.
‘True’ growth stocks have access to such opportunities.
Investments that earn below cost of capital will destroy value, regardless of what happens to top‐line sales growth
Cost of capital
a discount rate that reflects what investors expect to earn from investing in the company
Growth =
Investment rate x ROIC
Link between growth, ROIC and value creation
for all levels of growth, any increase in ROIC –> increase in value
but when ROIC is high, faster growth increases value
when ROIC is lower than company’s cost of capital , faster growth destroys value
ROIC = cost of capital neither increase or destroy value
Should low ROIC companies strive for growth?
Argument
Counterargument
Argument: if a company grows, its ROIC will naturally in- crease. However, we find this is true only for young, start-up businesses.
Counterargument: Most often in mature companies, a low ROIC indicates a flawed business model or unattractive industry structure.
If growth is a significant value driver, does getting bigger translate into creating value?
No. getting bigger does not translate into creating value. • Growth can harm value if the return on the growth is less than the cost of capital. Growth creates value if the return exceeds the cost of capital.
Link between ROIC, growth and cash flow
Higher ROIC = higher cash flow because because it means the firm need not reinvest as much to maintain its growth and operating cash flow
Cash flow can be broken down into growth and ROIC
What should high ROIC and low ROIC companies do
companies already earning a high ROIC can generate more additional value by increasing their growth rate, rather than their ROIC, while low-ROIC companies will generate relatively more value by focusing on increasing their ROIC.
i.e. high-ROIC companies should focus on growth, while low-ROIC companies should focus on improving returns before growing.
If value is based on discounted cash flows, why should a company or investor analyse growth and ROIC?
Although the discounted cash flow gives an estimate of value, the sources of value creation are growth and increasing ROIC. This is because increases in cash flow can be broken into growth and ROIC
when does growth destroy value
Growth destroys value when the ROIC on the new projects is less than the cost of capital.
