Do Investors Have An Accurate Picture Of Your Company's Value?

Is your company's strategy appropriately valued by the market? It's a critical issue for all senior executives. Traditional accounting-based metrics, such as earnings per share, return on investment and even economic value added, fall short of providing an accurate picture of value; P&L statements and balance sheets don't do the trick either. In fact, only a small percentage—about one-third, on average—of a company's value can be measured with these tools. More important, perhaps, there are no standard management metrics to track investors' future expectations for a company, which account for the majority of its value and reflect the confidence that investors have in the company's strategies. To get a complete picture, there needs to be a bridge linking accounting statements to market value.

 
Rather than merely tracking a company's EPS growth and the change in its price-to-earnings ratio to assess the relationship between share price performance and the company's strategy, Accenture has developed two new tools that begin to show the complete picture of what drives shareholder returns. These tools give executives insight into how the market views their announced strategies.

If they understand both the market's expectations for their future performance and what is driving those expectations relative to their peers, executives will be able to alter their strategies to meet and exceed these expectations. And by exceeding those expectations, they can increase the value of their companies and, thus, their returns to shareholders—the ultimate measure of high performance.

Comprehensive and Holistic
The first prong of Accenture's two-part approach is its patented Total Return to Shareholders Mapping Methodology. Simple in theory, TRS is the change in share price plus any dividends received during a given time frame. Accenture's TRS Mapping Methodology is comprehensive and holistic; it can be used to measure a company's performance on both an absolute and a relative basis, and it provides a framework to balance the imperatives of managing for both today and tomorrow.

The TRS Mapping Methodology shows how well the company is creating returns for shareholders by providing a framework to disaggregate the value of the company's strategies for scale, operations, growth and financing.

To understand scale, for example, we look at the amount of economic capital invested in the business. For operations, we look at economic profit—after-tax profit minus a capital charge—which reveals if the company's operating strategies are generating positive or negative results. Growth strategies are the company's future expectations in three areas: the assumption of a basic return to break-even economic profitability, after-tax profit growth at a nominal economic rate, and future strategic advantage or disadvantage. Financing strategies are the company's excess cash, dividends, share issuance, buyback policies or leverage decisions.

We then examine how much the company's performance in each category has changed on a yearly or quarterly basis, and how the company has fared in each category compared with its peers and the general market. We can then assess how the market views the CEO's success (or failure) in changing the company's relative share price—whether through cost cutting, capital expenditures, an acquisition, R&D, brand investment, a new growth platform, accumulating cash or another strategy. This analysis gives executives a picture of how they have driven or destroyed shareholder value over time, allowing them to see if the market has confidence in their plans.

The Zero-sum Game
We recently used the TRS Mapping Methodology framework to create the Accenture Market Value Model, the second part of our measurement approach. The model is based on the hypothesis that the market value of debt and equity is equal to the value of the total economic invested capital plus a break-even economic profit. This finding is in line with a principle established 25 years ago by Michael Porter, who argued that the market is rational and efficient over time.

But our model adds a new corollary to Porter's contention: It asserts that the market anticipates the growth of break-even economic profit at a nominal economic rate (we used a GDP growth rate of 4 percent) and that financing strategies are valued in direct proportion to their economic contribution. Our hypothesis reflects two factors that are broadly accepted by the investment community. First, competitive advantage diminishes over time, and second, investors expect the market to grow at only a nominal rate. This finding suggests that profit and future value premiums are a zero-sum game at the aggregate level.

We tested the Market Value Model(See Figure 1) on the Russell 3000 Index, which accounts for more than 90 percent of the US equity market. Our research¹ found that over both 10- and 15-year periods, our model was able to predict the market value within a slight deviation. Given such zero-sum-game findings, we believe that companies seeking to become high-performance businesses need to demonstrate differentiated strategies for scale, operations, growth and financing to first win and then maintain higher relative valuations.

At the industry and company levels, investors are constantly assessing the relative performance and strength of a company's scale investments, operating advantages, growth and financing strategies, leading the investors to valuation conclusions. Depending on what a company's strategies are and how well it executes them, it can defy gravity—the zero-sum game—and continue to create strong shareholder returns.

In fact, the market does appear to be highly rational, expecting that on average companies will follow only nondifferentiated operating and growth strategies over time. However, in the short term, not all companies and industries will be zero-sum. After determining value for industry sectors and the overall market, we can compare individual companies with that value and assess the four dimensions on which they succeed in (or fall short of) creating excess returns.

In the retail sector, for example, the market expects that the average company's current advantage and future advantage will both be valued at zero, growing at only the GDP rate. If a retailer's value sinks below the GDP rate, then either the company's share price is undervalued or investors are signaling their concern about the company's future growth or its ability to maintain the status quo.

We used our TRS Mapping Methodology and the Market Value Model to assess Wal-Mart. The company is an interesting example because, despite the fact that it is the standard-bearer for operational excellence, its market value has not increased in recent years. We found that Wal-Mart has lost its ability to convince the market of differentiated growth strategies and has fully "grown into" its current valuation (See Figure 2). Given Wal-Mart's record of stellar operating performance and scale growth, our model suggests it is undervalued. There is therefore a problem either in the market's perception of the company's strategies or an underlying issue with its external communications.

Only 25 percent of Wal-Mart's market value is future value, which actually implies growth that is slightly below GDP growth. Wal-Mart's valuation has not changed in eight years, though it has continued to improve its operations and increase scale.

Given Wal-Mart's ongoing ability to maintain capital efficiency and scale advantages, it is surprising that its market value points to growth rates below the nominal rise in GDP—especially in light of the fact that growth at several of its big box retail peers is projected to exceed GDP growth. Our TRS Mapping Methodology and Market Value Model show that the critical issue for Wal-Mart is that the market expects its economic profit to grow more slowly than the GDP.

Accenture management utilizes TRS Mapping as part of our internal financial analysis process, as it provides us with an additional market-focused view of the quantity and quality of shareholder returns being created in our sector.

The TRS Mapping Methodology shows how companies generate their returns. Our aggregate Market Value Model shows that, on average and over time, investors don't expect companies to have operating or strategic advantages.

For their share price to break out from the zero-sum game, would-be high performers need to demonstrate strong, sustainable comparative advantages in their strategies to scale, operate, grow and finance their businesses. They need to outperform their competitors in each of these categories to drive share price. Moreover, given the increased scrutiny of CEO pay, this model could also give executives a way to link their compensation to what the market thinks of their company's strategies and how the company executes against those expectations.

Instead of zero-sum, these companies will achieve a win-win.

¹The American Institute of Certified Public Accountants and the Enhanced Business Reporting Consortium have formally accepted Accenture's TRS Mapping Methodology and have recommended it to the International Accounting Standards Board as a best practice.

About the authors
John J. Ballow is an executive partner in the Accenture Finance & Performance Management service line and an executive fellow with the Accenture Institute for High Performance. Mr. Ballow has more than 25 years of experience as a corporate finance officer, advisor and strategist in corporate and finance management across multiple geographies and industries. His work focuses on enterprise valuation and performance management, corporate strategy, restructuring, mergers and acquisitions, financial management and finance operations. Mr. Ballow, who is based in New York, has led Accenture research on valuation, strategy and intangible assets, and he has authored numerous articles appearing in publications including Outlook, Journal of Business Strategy, and Journal of Applied Corporate Finance, as well as in the book CFO Insights: Delivering High Performance (John Wiley & Sons, 2006).

Sarah R. Maloney is a former research specialist with the Accenture Institute for High Performance.

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