Stern Stewart Economic Value Added (EVA) Analysis India 2008Excerpt from Mint 23 Feb, 2008, Sanjay Kulkarni Performance of Indian businessUsing Economic Value Added (EVA) and Market Value Added (MVA) measures, Stern Stewart takes a proxy universe of 500 companies to represent Indian industry and evaluate if Indian industry created wealth between 2005 and 2008 (latest numbers are still not available for all firms, so the study restricts itself to late 2008 numbers). While the answer in general is a “no”, it is heartening to see a few pockets that have created superior wealth. Does the underperformance of most companies come as a surprise —particularly when “managing for value” has become a popular refrain? The EVA is a registered trademark by its owner, Stern Stewart & Co. Not really, because in the real world the basics of “managing for value” seem to be forgotten with alarming regularity —managing a business for value creation is not just about being the biggest or the most efficient; it requires an appropriate balance between both size and efficiency and fundamentally rests on the principle that companies are supposed to take capital from investors and make it worth more. 
Check out MVA-EVA data for 500 Indian companies at Live Mint Indian companies have focused on size, not value creationWhile about 480 companies have increased in size, only 128 companies have actually grown their MVA (see chart on fundamental performance and market response). Interestingly, MVA per unit of capital has increased for only 73 companies—which essentially means that only about 15% companies have made contributions to increase the value of the capital over the three-year period. In a similar vein, around 305 companies have improved operating margins as well. Similarly, the aggregate operating margins of Indian companies have increased. However, this has been at the expense of poor capital turnover and resulted in a minuscule rise of just above 3% (or 1.1% in terms of compounded average growth rate) over the past three years. MVA (Market Value Added) = Market Value of Capital - Capital Employed EVA (Economic Value Added) = Net Operating Profit after Tax - Companies have focused on profit and loss, but there is scope to better manage the balance sheetOperating margins suggest the amount of profit generated through one unit of revenue and reflect how effectively the P&L (profit and loss account) is managed, while capital turns denote the amount of capital required to generate one unit of revenue and reflect how well the balance sheet is managed. It is interesting to see that over 2006-07, both the capital turns and operating margins have improved, leading to an increase in MVA of about Rs14.5 trillion (see chart on movement in net operating profit after tax or Nopat margin and capital turnover). But managing for value is not simply growing both capital turns and operating margins; it is about managing appropriate trade-offs between P&L account and balance sheet; between growth and efficiency; and between near-term and long-term performance. It is such decisions that separate winners—the positive MVA companies—from the rest. A combination of operating margins and capital turnover is reflected by the return on capital employed and adjusting this return to the risks of investing capital will indicate the EVA spread and provide a tool to make appropriate trade-offs. For example, while both winners and the rest have similar revenue growth and differentiate little on the profitability —the P&L items—it is truly the better balance sheet focus that separates winners from the rest (see chart on performance of positive MVA firms compared with negative MVA companies). Winners have fine-tuned art of short-term and long-term trade-offs better than restThe chart on winners corroborates the view—while the winners have grown the top line just as well as others, they have shown better Economic Value Added (EVA) growth and have created wealth. The rest, in contrast, have grown revenues, but have actually reduced EVA—and the markets have taken cognizance of this because they look for an improvement in Economic Value Added. Our survey suggests that while about 265 companies have improved Economic Value Added (EVA), all of them have not delivered wealth to shareholders—however, all the companies that have created wealth for shareholders have improved EVA! The catch here is in terms of understanding how much EVA improvement is good enough, and then going out and beating this hurdle on a sustainable basis.
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