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The research also sheds light on the importance of revenue growth in generating TRS, regardless of a company’s starting point. For instance, companies in our highest quintile for both EP and revenue growth generated TRS at 19 percent. But even the companies in our lowest quintiles for EP and revenue growth still generated TRS that was mostly positive (See Exhibit 2).
The importance of both metrics is clear; but it’s also worth noting that how you manage EP and revenue growth matters. In the long term, it doesn’t pay to increase EP at the expense of revenue growth. For instance, a company that cuts back on R&D expenses to improve its margins in the short term could also end up reducing its ability to launch new products and services—and new revenue streams. In our experience, companies that focus on long-term growth and EP tend to create more value.
Overall, our findings reflect the established finance theory: if executives are doing the right things strategically, they will see EPS, EP, and TRS all rise. However, EPS may also grow even when no value is created—for instance, in the case of an acquisition in which the purchase price exceeds the intrinsic value of the deal.
By contrast, EP is driven by returns on invested capital, revenues, and the opportunity cost of capital. So unlike EPS, it will increase only when value is created. Especially when considered alongside revenue growth, EP explains returns to shareholders very well—and better than EPS.
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