The Holy Grail of Shareholder Value Measurement

Few dispute the value of EVA as a performance measure, but some companies think that other metrics correlate more closely with long-term shareholder returns. However, if you’re looking for one perfect measure, you’ll likely be disappointed. Here are the pros and cons of the most commonly used metrics.

Investors have become a pretty savvy, if fickle, bunch. When a stock isn’t providing the rate of return they want, they probably won’t keep their money in it for long. This demand for immediate returns puts pressure on finance managers not only to ensure that their businesses earn profits, but also to find precise measures of shareholder value, a search that can be challenging. Today executives have more metrics to choose from than ever before. They must decide whether to focus on economic performance, cash flow, operating income, return on assets or all of the above.

Not long ago, economic value added (EVA), introduced by Stern Stewart & Co., a New York-based consulting firm, was the metric du jour. EVA purports to assess shareholder value by calculating the amount by which profits exceed the cost of capital. But does higher EVA translate into higher stock prices?

"EVA has a low correlation to shareholder value," says Eric Olsen, senior vice president in the Chicago office of The Boston Consulting Group. Companies that use EVA often try to increase short-term shareholder value by minimizing their cost of capital. Managers become reluctant to invest in future growth, because capital that hasn’t yet generated a profit reduces EVA. Obviously, such a short-sighted approach can limit a company’s growth.

"EVA probably wouldn’t be too useful for an Internet company like Amazon.com," says Julie Desjardins, a Toronto-based chartered accountant and consultant to the Canadian Institute of Chartered Accountants. "Earning a positive EVA isn’t all that important for most Internet companies. The key for them and for shareholders is their product pipeline [the Internet]."