Measuring Corporate Excellence
Tired of the same old ranking bias large companies perennially at the top or bottom of the list because of investment decisions made decades ago? And the ranking dictated by industry group rather than management? So are we. We want to know what each company delivered recently and how much was attributable to management, rather than business cycles or industry. In short, we want a measure of shareholder value that strips out the true opportunity cost of foregone investments elsewhere. We want XVA.
XVA is the market value premium or discount to economic book value that cannot be explained by the competition. Its the dollar amount of MVA created over a period of time which would not have been created from a like sum of capital invested in a peer group. Unlike MVA, XVA can be measured within industries and across industries without an embedded performance bias. And it differentiates good management from good luck, in both good times and bad.
Only by outperforming the actual competition for capital, not a theoretical fixed-rate of return, can a company register positive XVA. For it is only then that the company has surpassed the actual opportunity of foregone investments.
The same holds true for EVA ®. Thats why we created XEP, or indexed economic profit. Stated simply, XEP is the economic profit produced during a period that would not have been produced by a peer group which was equivalently capitalized at the beginning of that period. XEP is the internal analog to XVA.
It so happens weve tracked XVA and XEP extensively for the 1703 largest companies on any domestic exchange. Why 1703? Weve included any company whose market capitalization exceeded the smallest company in the S&P 500. That means 103 IPOs plus 1600 seasoned equities. It means insurance companies, electric utilities and banks not just industrial companies. And it means internal performance data dating back at least five years, even for the IPOs. More important, it means the same attention to economic accuracy and detail that you would expect from a shareholder value authority on its company-specific engagements. Weve invested considerable effort to restate financials historically, to convert performance measures to an economic, cash-flow basis, and to research all the hidden investments and charges (e.g., unrecorded goodwill during pooling-of-interest acquisitions) that dont appear in the footnotes. In short, weve conducted the largest, broadest and economically most intense survey of market and operating performance anywhere.
So do XVA and XEP make a difference?
Consider this. Wal-Mart placed 13th in our 1996 analysis of MVA. It placed 1560 in our analysis of XVA. Pepsi ranked 1507 in XVA, 19th in MVA. Coke, by contrast, ranked fourth and first, respectively. The top two slots werent surprising: Intel and Microsoft at first and second in XVA, first and third in MVA. But what about GE? Perennially on top in terms of MVA (18th in 1996), GE sank to 1578 in XVA. And General Motors, always at the bottom in terms of MVA, was at the bottom in terms of XVA.
If you believe opportunity cost matters, then youll want to see how your management team stacks up against the real competition for capital. Youll want to see whether investing long in your company while shorting the competition would have paid off. Youll want to see whether managements pay reflected its distinctive contribution to share value, not just the contribution of the industry and embedded capital. Most important, youll want to know whether your stock is regarded as an investment in good management, or a dime-a-dozen investment in a good industry. Youll be surprised and stimulated by the findings.
Weve made several of our compilations available for download in the research section of our website. Weve also begun mining the data ourselves, separating gold from pyrite. What follows are just a few of the nuggets from our research. Look for more in the coming weeks, as we feature each of our 102 industries. Chances are, well examine whether your company withstands the test of total management differentiation.
If ever there was a poster boy for EVA ® during the 1980s, it was Wal-Mart. From its modest beginnings in Bentonville, Arkansas, the company was the archetypal Company Z, perennially investing more than it earned, but earning so much more than its cost of capital that its MVA soared. By 1992, the year of Sam Waltons death, the retailers market value exceeded its book value by $46 billion an MVA record.
Fast forward to 1996 and a Wal-Mart on every corner. The orthodoxy is that Wal-Mart is cruising along comfortably. Its MVA ranking for 1996 was 13 out of 1703. Its EVA ranking was a respectable 606. Among broad line retailers, Wal-Mart was still ensconced at the apex, ranked first in MVA, fifth in EVA.
Imagine our surprise when Wal-Mart showed up 1560 out of 1600 in our indexed ranking of XVA. And 1630 out of 1700 in our survey of XEP. Well, maybe we werent surprised. Between 1991 and 1996, Wal-Marts average annual return to stockholders was negative 0.5 percent, versus 14 percent for other broad line retailers. Its five-year TSR rank was 1538 for the 1600 companies in our XVA sample.
What XVA delineates, in a single measure, is the rise or fall in MVA that cannot be explained by a comparably capitalized index of competitors. For Wal-Mart, that fall was precipitous. In absolute terms, Wal-Marts MVA fell from a peak of $64 billion in 1992 to $33 million at year-end 1996. Thats 50 percent further, in dollar terms, than MVAs black sheep of the 1980s, IBM (1985-1989).
To be sure, Wal-Marts market capitalization is still double its economic book value. But just think what others in the industry could have done with a like amount of capital. Or did in fact do. Wal-Marts 1997 XVA ranking versus other broad line retailers was 24 dead last. We estimate that of the $31 billion decline in MVA, all of it (actually $33 billion) was attributable to Wal-Marts distinctive woes not those of the industry. In fact, many members flourished, including those with large embedded levels of capital.
Sears, Roebuck ended 1996 with $7 billion in MVA on $27 billion of capital close to Wal-Marts $31 billion in capital but a far cry from its $33 billion in MVA. Still, relative performance matters. It is what distinguishes management excellence from mere industry fortune or embedded momentum. Under Arthur Martinezs expert stewardship, Sears delivered roughly $86 billion in MVA from 1991-96 that could not be explained by a comparably capitalized index of broad line retailers. Wal-Mart, by contrast, delivered negative $33 billion a differential of almost $120 billion. Put differently, Sears erased a $46 billion XEP deficit; Wal-Mart erased a $4.5 billion XEP surplus.
More significantly, Sears posted its MVA and EVA ® improvements on a rapidly growing capital base. Sure, it disposed of Dean Witter/Discover, and queued up AllState, but it also invested (on net) $23 billion in plant, property and working capital during 1987-96, nearly as much as the $27 billion invested by Wal-Mart. Sears may be a lesson in focus, but it is only partially a lesson in downsizing.
By the same token, its not that the discounters have been squeezed. Newcomer Costco, with $4.6 billion in capital, ranked fourth in our XVA ranking of broad line retailers. Woolworths and Dollar General were also near the top.
Among large department stores, Mays and Dayton Hudson topped our list. Both invested nearly $10 billion in capital. Of those, Mays had the higher MVA $8.2 billion versus $3.9 billion for Dayton Hudson. But over the last three years, Dayton Hudson delivered $3.5 billion in MVA that could not be explained by industry performance. May delivered $2.8 billion enough to make second on our 1 and 3-year rankings but not enough to win the award for distinctive management excellence. That award belongs, for at least three years running, to Dayton Hudson.
Ask almost anyone who the worst managed company was during the last twenty years and they will tell you, General Motors. Over the years, GM has destroyed $52 billion more than the $188 billion it invested. More sobering, GMs economic losses are not merely the legacy of Roger Smith. Under Robert Stempel and Jack Smith (no relation to Roger), GM continued to pour good money after bad, registering MVA declines of $27 billion from 1991-96 on $35 billion of newly invested capital. Not a record to be proud of, considering Chrysler erased a $2.8 billion MVA deficit during that same period with $6.3 billion in MVA on a mere $1.2 billion of investment. Chryslers XVA during the five-year period was $9.6 billion more than what Ford or General Motors together would deliver on comparable amounts of capital. GMs five-year XVA, by contrast, was negative $27 billion. Now thats opportunity cost.
So wheres the news? The news is, the all-time bottom feeder is not GM, but ITT and its progeny, ITT Hartford, ITT Educational Services and ITT Industries. Rand Araskogs once-proud empire destroyed $74 billion on $84 billion invested, leaving investors with a combined market capitalization of less than $10 billion. GMs combined MVA loss (adding EDS and Hughes) was a comparatively minor negative $46 billion on $213 billion invested. Of course, ITTs investors will see some of their foregone income returned in the form of stock from Starwood Lodging, but even a 30 percent premium would, on ITTs equity, recoup only $2.5 billion of the $74 billion lost.
More interesting, perhaps, is how much of the $74 billion was squandered recently, despite open pressure from Hilton and shareholder activists. ITTs 1996 XVA was negative $24 billion, its 3-year sum negative $27 billion. So GM shareholders, rejoice, there is still plenty of room in the cellar for company.
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