In our first few blogs in this series, part 1 part 2 part 3, we’ve talked about Economic Value Add (EVA), the simplest, most powerful metric to measure performance. EVA’s most important quality is its direct link to value. And it provides more than conventional management tools can. EVA not only calculates the same Net Present Value (NPV) that is used in forecast cash flows, it also provides clarity on the nature of the value itself. EVA gives insight into what the value is, why it’s valuable and how to improve it.
By focusing on EVA, executives can be confident that every decision which drives positive movement generates value for the firm. EVA works equally well when a firm needs to know a related measure, one that’s driven by the market. Market Value Added (MVA), which calculates the spread between a firm’s overall market value and its invested capital, calculates the difference between the cash put into a business and the value derived from it, at a point in time.
MVA effectively measures a company’s franchise value, its owners’ wealth and the company’s aggregate NPV. It is the market’s way of “summing up” the NPV of all existing and forecast capital projects. A rising MVA increases the owners’ wealth, and the organization’s TSR increases as a natural by-product. Maximizing MVA is ultimately every company’s most important goal. For public companies, MVA is one metric that should be on their dashboards.
What determines arguably one of the most powerful business metrics? What explains why a business will trade above or below the book capital put into the business? If you guessed EVA, you’re right. MVA equals the present value of the EVA profits that the market projects a business will earn. As EVA rises and falls and investors revise their EVA forecasts, MVA tends to follow suit.
The combination of EVA and MVA more accurately predicts earnings-per-share growth and P/E multiples. When using EVA and MVA together, organizations have a way to forecast how managers’ decisions will directly impact the firm’s future stock price or the overall value of the firm in an investor’s portfolio. It’s this powerful connection that prompted the editors of Fortune to label EVA “the real key to creating wealth.”
Regardless of industry, ownership structure, organizational complexity or size, EVA should be your firm’s “metric of choice” when making decisions that will impact economic value. EVA is straightforward. It’s powerful. And it’s deceptively simple, providing insight into the most complicated decisions. If you want to know what your organization’s value is today and where it can be tomorrow, all it takes is one simple calculation.