Magazine article Management Today

Watching the New Metrics

Magazine article Management Today

Watching the New Metrics

Article excerpt

Analysts may be talking about the death of eps and the rise of the new metrics, but managers are slower to ring the changes.

It's difficult to make out whether it's a passing phase or a change that's here to stay, but it's certainly something to think about. Analysts seem to be moving away from earnings per share (eps) growth as the key measure of a company's progress.

So far, there's no consensus on what should replace the old measure. Economic value added, or EVA, is merely the most boisterous contender. EVA's advance has been assisted by its ingenious positioning as a tool not only for investors, but for companies too. Listen to its inventors, Stem Stewart, and you might for a moment believe that to adopt EVA is to make your shareholders rich overnight. Not to mention yourselves, since EVA is also a management compensation system. So far, at least in the UK, few companies have hired Stem Stewart to show them how it's done, but the other prong of EVA's advance is faring well. You won't find many City analysts who aren't at least familiar with the EVA idea.

Then there's CFROI, or cash-flow return on investment. Holt, the Chicago firm which came up with this one, has had a London office hawking CFROI analysis to fund managers for two or three years now.

Stockbrokers James Capel are engaged in a courageous process of working out in public how to use the new measures. A recent 70-pager on the big spirits companies used a formula called economic profit analysis, or EPA, to distinguish the cognacs from the grappas (much distillation yielded little cognac). At the same time, Capel's building materials team, having earlier experimented with EPA, decided that it didn't take due account of inflation and moved on to their own version of CFROI, which they carefully distinguished from Holt's.

Meanwhile in its semi-annual bible of the FT-SE 100 companies, BZW gives prominence to a series of ratios based on enterprise value. In this, a company's profit before interest, tax and depreciation, is compared to the aggregate of its equity and debt. 'Enterprise value ratios,' promises BZW, 'overcome most of the difficulties associated with p/e and earnings growth models.' Morgan Stanley is equally keen on enterprise value while also emphasising the merits of CAP, or the competitive advantage period: that's how long a firm can hope to keep up any unusual level of profitability (which is also a crucial ingredient in Holt's CFROI and in EVA).

But EVA is definitely the market leader among the new metrics. Credit Suisse First Boston (CSFB), for one, has adopted EVA wholesale. 'If you're still relying on price/earnings ratios, you're 10 years out of date,' says managing director and head of equity research, John Conlin. NatWest seems likely to pour out plenty of EVA too. Last year its conglomerates team put out a widely quoted circular demonstrating how all those earnings-enhancing acquisitions had been doing just the opposite for the intrinsic value of the acquirers. Now their colleagues are all being packed off to a course on EVA run by financial training firm BPP.

So there's certainly something going on, although so far, that's all. None of the above firms have dropped the old apparatus of eps and p/e ratios. Nor are they going to. It's too engrained to be swept away. It's also, frankly, just too useful. EVA, CFROI and all the rest take plenty of working out, a lot of ferreting in the small print of annual reports, and a bold approach to the art of making assumptions. Earnings per share, by contrast, can be simply lifted out of the annual report. In fact, investors don't even need to go that far: reach for any directory from the Hambro Company Guide upwards, and there the numbers are, abstracted, adjusted and rendered into p/e ratios.

Even so, the 'something's going on' has reached the stage at which companies are beginning to acknowledge it. In doing so, they have to address two issues. …

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