Does the Wealth Profile of a Company Matter in Discounted Cash Flow Analysis? Valuation Implications for Investors
and Managers

Abstract

This article examines the prospective valuation relationship between MVA and EVA. The author classified companies in the Stern Stewart Performance 1000 Universe in terms of whether they are in a tier 1 wealth profile (top-100 MVAranked companies), a tier 5 wealth profile, or a tier 10 wealth profile (bottom-100 MVA-ranked companies). Overall, the results that the market discounts economic earnings and that the wealth profile of a company matters in particular. Specifically, indicate the market discounts economic earnings for wealth creators, as opposed to the middle-to-low MVAranked companies. Consistent with financial theory, this implies that reliably positive EVA—such as that evident in the wealth creators—has intrinsic value, whereas relatively lowto-negative EVA—as present in low MVA-ranked companies—has questionable fundamental value. The author argues that wealth creators know how to rationalize capital, as they pursue positive NPV opportunities where the return on capital is higher than the cost of capital. On the other hand, low-to-negative MVA-ranked companies face risk pricing challenges as investors question the efficacy of their ability to create shareholder value. Although caveats apply, this prospective valuation of EVA has important pricing implications for investors and managers.

TOPICS: Fundamental equity analysis, accounting and ratio analysis, statistical methods