Finance mortgage nvr

Like the wicked queen in the tale of Snow White, analysts are forever trying to identify the fairest of them all-the strongest, most innovative, and fastest-growing companies. Finance executives, in turn, are constantly seeking a metric that communicates a company's financial condition in a way that enables employees to make rational decisions about operations. There is no shortage of metrics, but as the past two years have witnessed, many of them, in particular EBITDA and pro forma, have been vulnerable to distortion.

Enter MVA, or market value added, which measures the amount of wealth a company has created since its inception. MVA is an extension of EVA (economic value added), a metric that became popular in the 1990s, when companies used it to measure profitability not just at the corporate level, but also at the level of business units and individual projects.

EVA is described by Bennett Stewart, senior partner at consulting firm Stern Stewart & Co., which has trademarked the acronym, as an estimate of the amount by which earnings exceed or fall short of the rate of return shareholders and lenders could get by investing in other securities of comparable risk. "EVA is a practical method of estimating the economic profit that is earned, as opposed to the accounting profit," he says. "It's really a finance tool for non-finance executives. Finance execs don't need EVA]'

"It simplifies everything," insists Sal Fazzolari, senior vice president, CEO, and treasurer of Harsco Corp., a Camp Hill, Pennsylvania-based industrial-services firm, which began implementing MVA and EVA as financial-measurement

tools in 2001. "It's one measurement for everyone in the company to concentrate on. It takes into consideration all of a company's financials."

At the heart of MVA and EVA are the beliefs that (1) the primary objective of management should be to maximize return to shareholders and (2) a company should earn more than its cost of investment.

In a nutshell, EVA is equal to a company's net operating profits after taxes (NOPAT) minus a capital charge--the amount of capital invested in the business times the cost of capital. EVA converts the balance sheet and income statement into one measurement of profit, Stewart explains. "It's as if the company ended up with no assets and leased everything, factored all receivables," and so on, he says, adding, "it's the profit that would be reported if all assets were externally financed." Stewart argues that looking at financials in this way enables a company to truly understand whether it is profitable because it manages assets well or simply because it is an owner of assets.

Fazzolari says that for many years, different business units at Harsco focused on a variety of metrics, such as return on capital, return on sales, net income, and sales. "These metrics can send you in different directions," he says. "EVA makes you focus on all of the financial statements."

EVA has enabled Harsco to improve its capital-allocation process by stanlardizing the way each manager and employee analyzes a project. For example, if a customer requests an extra 30 days to pay its bill, Harsco's employees can immediately calculate the potential financial impact on the company. Each month, Harsco calculates EVA by business unit. "It is automatically generated," says Fazzolari. Each employee can then access the tools needed to calculate EVA.

At consulting firm Accenture, EVA performance is linked with compensation for the firm's partners. "A big portion of our partners' and units' compensation is based on EVA generation;' explains CEO Harry You. You likens EVA to a more precise version of return on invested capital. He also uses EVA in doing business with clients. "We look at the way we can create EVA for them," he says. "We're selling our business based on how we sell EVA to our clients. A vast majority of our clients may not use it, but they understand it."

DEFINING MVA

"EVA is the most important empirical link to MVA," says Stewart. The change in EVA explains 35 percent of the change in MVA, or seven times more than sales growth, while the change in earnings per share explains only about 3 percent of the change in MVA.

MVA itself is the stock market's assessment of the net present value (NPV) of EVA. In other words, MVA is the difference between the market value of a company (which includes both equity and debt) and the capital that lenders and shareholders have entrusted to the company over the years. Thus, MVA is a measure of the difference between "cash in" (what investors have contributed) and "cash out" (what they could get by selling at today's prices), Stewart explains.

If MVA is positive, it means that the company has increased the value of the capital entrusted to it and thus created shareholder wealth. IfMVAis negative, the company has destroyed wealth.

Like all other metrics, says Accenture's You, MVA has its limitations. For one thing, like a company's price-to-earnings ratio, it is in part captive to the vagaries of the stock market. "Over longer periods, MVA correlates with EVA, but over a shorter time, it may not," he insists.

On the other hand, MVA is a better measure of a company's shareholder-wealth creation than simple market capitalization. Take, for example, Verizon Communications. The telecom giant's market value is $200 billion, nearly the size of Microsoft's. Although one would think the two companies therefore rewarded their shareholders equally, Microsoft's MVA is 13 times greater than Verizon's. This is because Verizon issued $65 billion of stock to buy GTE in 2000, skewing its market value growth. And this transaction followed by just three years the all-stock merger of Bell Atlantic and Nynex that first created Verizon. In the past 10 years, Verizon's total return to shareholders has been only 7.84 percent, according to Stewart.

ALL HIGH PERFORMERS ARE HOT ALIKE

The top three performers, according to the MVA ranking of Tier-1 companies, are General Electric, Microsoft, and Wal-Mart Stores. (Note: The rankings delineate Tier], Tier 2, and Tier 3 companies by size.) Although representing diverse industry sectors and business strategies, all three companies have created nearly the same amount of wealth for their shareholders-GE, $223 billion; Microsoft, $212 billion; and Wal-Mart, $207 billion.

Wal-Mart had $246 billion in sales in the most recent year, while Microsoft had "only" $31 billion. GE has $156 billion in long-term debt, while Microsoft has none. Microsoft's return on average capital is nearly twice that of the other two companies.

Of the top three companies, GE has the highest MVA and highest EVA. Wal-Mart's EVA is higher than Microsoft's, which means that the market is projecting different rates of growth for these companies. The fact that Microsoft has about the same MVA but a much lower EVA than GE means the market believes Microsoft has a greater opportunity to grow. This is partly underscored by its 22 percent return on average capital, which is nearly double that of its two MVA peers.

What does it mean that GE has the highest MVA and EVA? "If the MVA for GE is the same as for the other two companies, that means GE has less prospect for growth compared with the other two," Stewart explains. In fact, although its EVA has grown somewhat over the past three years, its MVA has eroded by more than 17 times that of Wal-Mart over the three-year period. "[Its MVA score suggests] that GE doesn't have the same intrinsic growth opportunity.

"Wal-Mart has stupendous growth prospects but the lowest return on capital, so it has significant growth at lower margins. Microsoft, on the other hand, is a higher-growth, higher-return company. GE has a low-return, low-growth base, and a modest chance to grow its EVA;' he adds.

Perhaps the most impressive large companies in the Tier-i ranking are Procter & Gamble and Johnson & Johnson, which show the best three-year improvements in MVA. (Changes in rankings between 1999 and 2002 are shown on the charts beginning on page 62, while three-year averages for EVA and MVA are available at www.cfo.com.) Procter & Gamble leaped from number 32 in 1999 to number 6 in 2002 in terms of MVA. Biopharmaceuticals company Gilead Sciences showed the highest three-year MVA gain among the 25 largest market-cap companies with less than $700 million in revenues, rising to second place from number 174 three years ago.

Technology companies rank high in terms of MVA despite the short life span of many new technology and Internet companies. Six of the 14 top large companies are tech companies; Ebay and Qualcomm fall among the top four midsize (Tier 2) companies, and Linear Technology is the highest company with sales below $700 million (Tier 3). From 1999 to 2002, Ebay, in fact, moved from number 25 to number 2 among companies with sales between $700 million and $7 billion, and now boasts twice the MVA of Amazon.com.