Economic Value Added™ (EVA™)

Common Sense

The term Economic Value-Added™ was not coined by money management types. Rather, it was coined (and trademarked) by a consulting firm (Stern Stewart) and made famous by a self-congratulatory essay published by Coca-Cola Company a few years back. EVA™ measures the "economic profit" a firm generates, with "economic profit" defined as after-tax operating profits, less an appropriate charge to reflect the capital employed in the business. We mention EVA™ here because its burgeoning popularity constitutes one of three main drivers of the recent bull market in stocks — not only in the US but in foreign bourses also. To be sure, EVA™ is not the term used by some companies, or some investors, to describe their growing obsession with enhanced "shareholder value," but regardless of semantics the idea is the same: to maximize the spread between a firm's return on capital and the cost thereof. For many publicly traded companies, this spread has improved hugely in recent years, causing investors to rerate their stocks accordingly (i.e., higher). When combined with the bull market's other main drivers — disinflation and privatization — the flowering of EVA™ -like approaches has produced historic gains for equity investors. Due partly to the fact that their EVA™ scores were so low when "shareholder value" first came into vogue in the 1980s, large companies such as Coca-Cola have made the most conspicuous strides toward EVA™ heaven and have thus generated (until recently) the most conspicuous gains for shareholders. Ironically, since the average active manager tends to be underweighted in large stocks relative to the S&P 500, the EVA ™ movement has caused the EVAs™ of many active US stock managers to plummet — into negative territory.