Academic journal article The McKinsey Quarterly

Corporate Strategy in a Globalizing World: The Market Capitalization Imperative

Academic journal article The McKinsey Quarterly

Corporate Strategy in a Globalizing World: The Market Capitalization Imperative

Article excerpt

Many companies still want to be big fish in national ponds

But that won't generate the high market values that will keep them independent

Nothing mutters more than return on equity

Few would now dispute that technological innovation, deregulation, and trade liberalization are opening up many of the world's economies to competition from global players. There is much less consensus, however, about what these changes might mean for the size and scale requirements of any given business.

Consider the US companies shown in Exhibit 1. Each generates at least 30 percent of sales outside its domestic market; the proportion for Procter & Gamble, AIG, and Citicorp is about half, and for Coca-Cola, almost three-quarters. Each has also increased its market capitalization more than eightfold during the past thirteen years; Coca-Cola's increase was a whopping 1,700 percent. By contrast, the S&P 500 rose by just 547 percent over the same period.

Why should you care? Because such enormous market capitalizations provide these companies with a real edge in acquiring other companies and capturing global growth opportunities, while protecting them from acquisition at the same time. Conversely, slow growth in market capitalization renders a company vulnerable, particularly as global equity markets integrate. Public companies thus face a market capitalization imperative: they must either become (and remain) great global growth companies, or risk losing control of their destiny.

Building global market capitalization

How do you get the market capitalization you need to compete and win? Recent research indicates that the answer lies in a combination of rapid earnings growth and increasing returns on book equity, with the emphasis on the latter. We analyzed the 100 global companies that had seen the greatest increase in market capitalization since 1992. Collectively, they grew from almost $1.8 trillion in 1992 to $4.6 trillion in 1997 - a compound growth rate of 24 percent, as against the market average for all large stocks worldwide of about 14 percent. This outstanding performance is not surprising given that the group's earnings increased at a compound rate of 23 percent during this period, while their return on equity (ROE) rose from about 11 to 19 percent.

The 100 companies in the list represent many different countries and industries. Fifty-eight had their headquarters in the United States, one was based in Canada, 30 were European, and 11 were from Asia (mostly Japan). Thirty-two were in largely globalized industries such as petroleum and automotive, 16 were in the "born global" electronics industries (computers and software), 31 were in rapidly globalizing industries including consumer packaged goods and pharmaceuticals, and 21 were global companies operating in mainly local industries such as food, insurance, and banking.

We took the spectacular growth in market capitalization for these companies and broke it into two components: increases in book value and increases in market value over book [ILLUSTRATION FOR EXHIBIT 2 OMITTED]. Not surprisingly, the growth in market capitalization is primarily due to a rise in market value over book value, rather than to growth in book value. The collective market-to-book ratio of the 100 global companies rose from 2.1 in 1992 to 4.2 in 1997, when the US average was about 2.

To understand this increase, we divided the 100 companies into quartiles that reflected their market-to-book ratios in 1997. The first quartile had a very high market-to-book ratio of 10.7; the second a high ratio of 5.6; the third a slightly high ratio of 3.2; and the fourth an average ratio of 1.9. Notably, there was only a slight difference in the compounded growth in market capitalization of these four groups, with the highest quartile growing at 26 percent and the lowest at 20 percent. The growth in the collective market-to-book ratio itself varied across the four quartiles, but the ratio of the highest and lowest quartiles grew at about the same rate. …

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