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In Times of Volatility and Uncertainty, Companies Should Refocus on the Real Essence of Value Creation

November 27, 2018

BOSTON, Nov. 27, 2018 (GLOBE NEWSWIRE) -- During the ten-year bull market, companies’ share prices seemed almost to soar at will: ten years of uninterrupted economic growth and low interest rates provided strong and consistent tailwinds for shareholder value creation. As a result, some leaders may have taken the focus off of what truly builds value within a company. As market volatility and economic uncertainty come back into play, companies may need to reconsider the essence— and hard truths—of the ways that a company creates value.

Enter a new publication from Boston Consulting Group (BCG), “Ten Lessons from 20 Years of Value Creation Insights.” Based on cumulative knowledge gleaned from studying the ways that top companies created value for owners over various five-year periods dating back to 1999, the article distills what BCG has found really matters—and where management often goes wrong—when it comes to value creation.

One salient truth: medium- to long-term total shareholder return (TSR) should be a key metric for value creation in public companies. TSR is balanced and accounts for all factors that drive value: revenue growth (from reinvestment in the business), margin expansion (from cost control and pricing), and cash flows (which can be reinvested for more growth or used for other value-creating purposes).

“Substituting any proxy metric for TSR inevitably leads companies off course. When earnings per share (EPS), for instance, is the principle governing metric, managers can end up ‘buying’ increased EPS by making excessive capital expenditures, ill-advised M&A moves, or poorly timed stock buybacks,” says Alexander Roos, a BCG senior partner and coauthor of the article.

“TSR, measured over a three- to five-year period, gives strategies the chance to be implemented and investments the opportunity to mature. It is the only performance metric that appropriately scores the game. That’s why it’s the only multiperiod metric mandated by the US Securities and Exchange Commission,” says Eric Wick, a BCG senior partner and coauthor of the article.

The following are among the other important value creation lessons and truths the article brings to life:

-- Every company can find a path to value creation. Although managers often feel trapped by the state of their industry or macroeconomic factors, there is a value-creating road forward from almost every starting point. TSR is a relative as well as absolute metric, so it is possible for every company to outperform peers, regardless of whether or not the company is in a sector with below-average market performance. -- Growth isn’t the only path to value creation outperformance. It is true that for top performers over five- to ten-year periods, revenue growth accounts for 50% to 70% of value creation. But managers must remember that myopic or ill-advised pursuit of growth—M&A gone bad, poor prioritizing, betting on a cycle that collapses—is one of the most common avenues to value destruction. Many top-quartile value creators generate value through a combination of such factors as margin improvement and cash returns. -- Cash flow is underappreciated. Cash accounts for most of the TSR a company generates over time. About 40% of the TSR of the S&P 500 since 1926 has come from cash returned through dividends. Cash generation is the main driver for growth businesses: it defines the magnitude of a company’s long-term reinvestment rate—organic or through M&A. -- Despite its bad rap, M&A is a powerful tool. While it’s true that more than 50% of deals simply transfer wealth from buyer to seller, many leading long-term value creators engage in significant numbers of M&A deals. M&A is one way—and there aren’t that many others—to reinvest large amounts of capital, and well-sourced and executed deals can serve up substantial returns. -- The shape and form of a company’s investment opportunities are more important than the precision of the calculations used to assess them. In many cases, senior management wastes time and energy trying to get the data inputs exactly right for modeling investments. For instance, management focuses too much on the cost of capital. What managers should be focusing on is how a proposed investment compares with the next-best use of capital.

Other value creation lessons: treating investors like customers pays dividends over time; focusing too much on metrics hinders the pursuit of value creation; and valuation multiples are no longer—and shouldn’t be seen as—an inscrutable black box.

“The proliferation of new business models in the digital age is sometimes interpreted as making value management less relevant when, in reality, the opposite is true. The use of TSR as a North Star that guides value-creating agendas and the application of the hard-won, timeless principles of value creation are more important than ever,” says Hady Farag, a BCG associate director and a coauthor of the article.

A copy of the report can be downloaded here.

To arrange an interview with one of the authors, please contact Eric Gregoire at +1 617 850 3783 or gregoire.eric@bcg.com.

About Boston Consulting GroupBoston Consulting Group (BCG) is a global management consulting firm and the world’s leading advisor on business strategy. We partner with clients from the private, public, and not-for-profit sectors in all regions to identify their highest-value opportunities, address their most critical challenges, and transform their enterprises. Our customized approach combines deep insight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable competitive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with offices in more than 90 cities in 50 countries. For more information, please visit bcg.com.

Boston Consulting GroupEric GregoireGlobal Media Relations Senior Manager

Tel +1 617 850 3783gregoire.eric@bcg.com

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