Time to Rethink Performance Metrics and Valuation Methods
Heilman, Jeff, Chief Executive (U.S.)
GAAP, EPS and P/E are dead. The days of financial astrology are numbered. Here's how leading investment thinkers measure real performance. BY JEFF HEILMAN
For an all-natural extract of a company's current harvest and future yield, investors should perhaps make a beeline for the Buffett table. Back in 1959, before Berkshire Hathaway, Warren Buffett's balance sheet analysis-husking the com and counting the kernels-was on the money, transforming $100 into $25 million 13 years later.
Yet, Buffett is not alone when it comes to reality-check valuation methods, as a climate of scrutiny and activism accelerates revisionist thinking in corporate income and performance measurement. In particular, patience for short-term accounting-based earnings-blamed for skewing decision-making, sandbagging budgets, corrupting healthy balance sheets and thwarting shareholder value-is wearing thin. For prospectors, forecasting a company's future cash-generating capacity remains the elusive prize, but to date, their clairvoyance has rested in the tea leaves of earnings-per-share (EPS) growth. Nonetheless, both tenets-future cash flow and present earnings-are the meat and bones in a percolating stew over performance and valuation methodologies.
There is an emerging consensus that the old valuation methods don't work. A new sensibility about performance metrics-already profitably in place at companies such as Best Buy, Hilton, Harsco and Ingersoll Rand-is getting increased investor attention. Dr. Trevor Harris, Morgan Stanley's vice chairman of client services and former global head of the firm's valuation and accounting team, for example, suggests that "with the proliferation of hordes of electronic data and analytically oriented investors, many accounting measures and disclosures that we live with today will be defunct, irrelevant to capital markets participants in less than 10 years."
The New Science
Unlike Jack Nicholsons court-room tirade in the military drama A Few Good Men - "You can't handle the truth!"-the refrain of choice in the realm of performance metrics is "What are you prepared to believe?" says Joseph Fuller, CEO and co-founder of renowned Cambridge, Mass.-based consultancy The Monitor Group. Fuller, author of a series of articles on valuation, sees a tacit reframing of investment rationales under way, based on creating and fulfilling expectations, not on making numbers.
"Historically," he says, "companies present Wall Street with a financial synthesis of their strategy. Financial forecasts, however, are an incomplete and disconnected telling of the corporate story, further strained by stretching to meet quarterly guidance and often producing overstated growth targets or understated risk factors." The better path, in Fuller's view, is to communicate the drivers that management believes will produce value and to prepare investors to believe in the investment. "Creating a tangible level of expectation, excitement and candor around a strategy; its underlying value propositions; and its risks and uncertainties," he says, "is more persuasive and measurable than contrived, contorted math."
In fact, according to a recent Monitor poll of more than 350 executives, strategy execution ranks as the single most important corporate issue today. Helping organizations become strategy-focused with breakthrough results is the Balanced Scorecard Collaborative (BSCol), a division of the global professional services firm Palladium Group, which is owned by Monitor's private equity group. "BSCoI and its signature performance management system, the Balanced Scorecard (BSC), arose from a 1980 KPMG-funded project addressing the declining global performance of American companies," says Dr. David Norton, who co-created BSC with Dr. Robert Kaplan, "and has evolved from a simple measurement system into a way for companies to translate strategy into day-to-day operational, planning, budgetary and compensation management. …