Here is an excerpt from an article written by Nicolaj Siggelkow and Phebo Wibbens for Harvard Business Review and the HBR Blog Network. To read the complete article, check out the wealth of free resources, obtain subscription information, and receive HBR email alerts, please click here.
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It’s a well-known paradox. Most executives are committed to the idea of maximizing long-term shareholder value, but when they want to track and improve performance, they focus on a dizzying variety of short-term measures (and acronyms). ROA. ROC. TSR. EBIT. EBITDA. CAR. EPS. We could go on.
Why this focus on short-term measures? In large part, because they’re easy to obtain, easy to use, and have been widely used in the past. The problem, as studies have long made clear, is that optimizing short-term accounting measures and ratios often doesn’t maximize long-term value. To think clearly and effectively about long-term value, companies need a better measure — and, as we write in a recently published article in the Strategic Management Journal, we’ve devised one that we call LIVA, short for Long-term Investor Value Appropriation.
The idea behind LIVA is simple: Add up the net present value of all the investments a firm has engaged in over a long period of time. The key insight from our analysis is that this can be done by using publicly available stock-market data. LIVA uses historical share-price data to calculate the value a company has either created or destroyed for its entire investor base over a long time period.
To see what LIVA can do, consider the case of Apple. Imagine you were fortunate enough to have bought 100 shares of the company’s stock in 1999. If you had reinvested any dividends and sold your shares 20 years later, you would have made an annualized return of 27%, well above the market average of 6%. That’s a healthy return, but hardly spectacular. In terms of total shareholder returns (TSR), it ranks 3,175th among companies worldwide over this time period — a ranking that would seem to suggest that Apple’s success hasn’t been very exceptional. One might derive the same conclusion from the most recent “Value Creators Rankings,” published annually by the Boston Consulting Group, which is based on five-year TSR and ranks Apple #34.
The problem is that TSR doesn’t actually measure long-term value creation for the entire shareholder base over a particular time period, but only the returns for those who held (a certain number of) shares over the entire period. LIVA, however, takes into account that the capital base of a company can change over time. In doing so, it provides a very different sense of the value Apple has created. If in 1999 you had bought the entire company at its then-market price, accounted for any cash received through dividends or share buybacks, and gone on to sell it 20 years later at its much-improved market price, you would have been more than a trillion dollars richer than if you had invested the same amount of money in an index fund. Apple’s LIVA over this period, in other words, was more than $1 trillion. That’s truly dominant performance that makes Apple the world’s number-one company in our ranking, with a LIVA 57% higher than that of Amazon, our number-two company.
Those rankings come from a global LIVA database we’ve created to help managers and researchers identify the best- and worst-performing companies by country, region, and industry. The database tracks the performance during the past 20 years of more than 45,000 companies that had at least $100 million of initial market capitalization and for which data was available for at least five years. It allows analysis of value creation at the level of individual companies, industries, and countries.
A comparison with traditional performance measures shows how much more revealing LIVA is, as becomes clear when you look at the top and bottom 10 performers as determined by each method.
Value Creators: The Global Top 10
The top five companies on our LIVA list are tech companies that together have created more than $2.6 trillion in shareholder value in the past 20 years. If you look at the top companies on the excess-return list, you’ll see that although successful, they haven’t generated anything like that kind of value. They were able to achieve very high returns, in fact, only because they started out small, with an initial average market capitalization of $332M. For example, the market capitalization of the number-one company on the list, Pharmasset, was $187M in 2007 and shot up to $11.2B in 2011, when it was acquired by Gilead. (We’ve excluded companies with less than $100M in market capitalization; their inclusion would certainly lead to even higher potential figures of excess returns.)
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Editor’s note: Every ranking or index is just one way to analyze and compare companies or places, based on a specific methodology and data set. At HBR, we believe that a well-designed index can provide useful insights, even though by definition it is a snapshot of a bigger picture. We always urge you to read the methodology carefully.
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