WHY EVA?
Economic Value Added (EVA) is a measure of corporate financial performance that takes the Cost of Capital out of the Net Operating Profit in order to measure, observe, and understand the financial performance and health of a company.
Economic Profit, or EVA, is an estimate of the amount by which Net Operating Profit After Tax (NOPAT) exceeds or falls short of the required minimum rate of return that shareholders and lenders could get by investing in other securities of comparable risk.
Don't current accounting techniques show that already?
Common practice looks at financial statements from an Accounting Profit perspective, allowing us to see the logic behind the value of the company, not the actual wealth creation. However, Economic Profit takes into account factors that have a real economic impact on the company and that are not considered by common accounting techniques, such as leases. The result is that favourable-looking Accounting Profit can potentially hide precarious or even disastrous economic positions which would otherwise be revealed using an EVA analysis. The recent Enron case is a good example of the limits of an Acconting Profit-based analysis.
Why would I include EVA in my analysis?
EVA is a better measure of period performance because it combines the balance sheet as well as income and cash flow statements into one measure and carries an explicit charge for the weighted average cost of all sources of capital (WACC). Thus, EVA better quantifies operating performance often before and more clearly than other traditional measures.
By using an EVA valuation method, you are better able to:
Evaluate companies using the same parameters
EVA systematically levels the playing field for comparisons across companies or industries on a more meaningful basis.
Make key decisions with positive, lasting impact
The EVA framework allows investors
to more systematically quantify the economics of a business,
bringing new discipline to support their selection process.
StockPointer's research database supports EVA's use in security
analysis for investors, equity research analysts, investment
advisors and portfolio managers.
View our ENRON Case study and see how an EVA analysis could potentially identify similar situations before it is too late!
