Measuring, maximizing shareholder value

One of the most well-known valuation metrics in the 1990s was the value-based performance measure called Economic Value Added or EVA.

The EVA, a registered trademark of Stern Stewart and Co. based in New York, aims to help managers find ways to improve their performance in the company by creating shareholder value.

Except for a number of proprietary accounting adjustments involved in the calculation, the concept of EVA is very similar to that of the residual value model.

We have discussed in past columns that, following a residual value model, the size of a company’s value creation is dependent on the spread of its return on invested capital (ROIC) against its weighted average cost of capital (WACC).

To compute for EVA, we multiply the residual spread of a company’s ROIC and WACC against its invested capital.

For example, if the ROIC of Robinsons Retail is 10.2 percent and its corresponding WACC, at current market yield, is 6.4 percent, we can calculate the company’s residual spread at 3.8 percent.

By multiplying this spread of 3.8 percent against the company’s invested capital of P89 billion, we can compute for its EVA at P3.4 billion.

The EVA is our estimate of a company’s economic profit, which is the amount of value created in excess of the required return demanded by its debt and equity investors.

Now, imagine if the company’s operating profits will slow down this year, its ROIC will also go down, which lowers its EVA. In the same way, if the 10-year bond yield continues to fall, its WACC will reduce, which increases its EVA.

Either way, the changes in ROIC and WACC can directly affect the EVA of a company. Historically, a rising EVA can translate to a higher share price, while a falling EVA can result to lower a share price.

The impact of EVA on the share price can be traced through the changes in the market value added, or MVA, of a stock.

The MVA, which represents the stock market’s assessment of a company’s ability to create value for its shareholders, is the present value of all future expected EVAs of a company.

In theory, if we compute the MVA of Robinsons Retail by discounting its EVA of P3.4 billion with its WACC of 6.4 percent, we can derive a target value of P53 billion.

But in practice, we can simply deduct the company’s invested capital of P89 billion from its current enterprise value of P96 billion to get an actual MVA of only P7 billion.

This huge difference in MVA means the current share price of the stock makes the company undervalued by as much as 32 percent.

Most of the big-cap stocks in the Philippine Stock Exchange index are mostly overvalued, either because they have negative EVA, or they have excess MVA.

But despite this, there are few stocks with positive EVA that are still undervalued by MVA standards.

These stocks are DMCI Holdings, which is underestimated by 49.6 percent; First Gen Corp, 65.7 percent; ICTSI, 14.7 percent; Globe Telecoms, 63.7 percent; PLDT, 55.3 percent and Puregold, 27.4 percent.

If we will look at the nonindex stocks, we will find that roughly half in the group have positive EVA, but only a handful are currently undervalued by MVA.

These stocks are led by GMA Network and Ginebra, which are both underestimated by the market with over 80 percent discount in their enterprise value.

This is followed by Global Ferronickel, 64 percent; Apex Mining, 60 percent; DM Wenceslao, 54.1 percent; Manila Water, 53 percent; Atlas Mining, 49 percent; Sta Lucia Land, 44 percent; Nickel Asia, 23 percent; and 8990 Holdings, 28 percent.

It has been said that the primary goal of a company was to increase shareholders’ wealth by maximizing the difference between its market value and the capital contributed by its investors.

Companies that are able to increase their MVAs over time generally attract more investments, because having high MVA not only indicate positive returns in the future, but also strong management.

But in a difficult time like this, maximizing wealth can be challenging because real MVA may not necessarily reflect in the share price. INQ

Henry Ong is a registered financial planner of RFP Philippines. Stock data and tools provided by First Metro Securities. To learn more about investment planning, attend the 89th batch of RFP program this May 2021. To register, email [email protected] or text at .0917-6248110