Eva & Shareprice 2: (Type The Company Name) - Error! No Text of Specified Style in Document. 1
Eva & Shareprice 2: (Type The Company Name) - Error! No Text of Specified Style in Document. 1
Eva & Shareprice 2: (Type The Company Name) - Error! No Text of Specified Style in Document. 1
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1. RESEARCH EXTRACTS:
The EVA is computed and compared with the respective share prices of 20
companies of the SENSEX for a period of 5 years beginning from FY 2002-03
to FY 2006-07.
From the study it is observed that there is there is no relationship between EVA
and share prices but EVA is the true profit that the company is able to generate
which also considers opportunity cost of the capital invested in the business.
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EVA & SHAREPRICE 2
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The study adds that EVA is the one of the measure, which is used to measure
the performance of the company but it cannot be used to forecast the share
price of the company.
2. INTRODUCTION:
Stern Stewart & Co, a consulting firm based in New York, introduced the concept
of EVA as a measurement tool in 1989, and trademarked it. The EVA concept is
often called Economic Profit (EP) to avoid problems caused by the trade marking.
EVA is so popular and well known that all residual income concepts are often
called EVA even though they do not include the main elements defined by Stern
Stewart & Co (Pinto, 2001)
Stern Stewart developed EVA to help managers incorporate two basic principles
of finance into their decision making:
1. The primary objective of maximizing the wealth of its shareholders; and
2. Accepting that the value of a company depends on the extent to which
investors expect future profits to exceed or fall short of the cost of capital.
Today, this mechanism enable all types of firms to determine their value creation
and share holders to determine the value created on their investments. The first
question coming to our mind after reading this is:
By taking all capital costs into account, including the cost of equity, EVA shows
the monetary amount of wealth a business has created or destroyed in each
reporting period. In other words, EVA is the profit as defined by the share holders.
The capital charge is the most distinctive and important aspect of EVA. Under
conventional accounting, most companies appear profitable but many in fact are
not. As Peter Drucker put the matter in a Harvard Business Review article, "Until
a business returns a profit that is greater than its cost of capital, it operates at a
loss. Never mind that it pays taxes as if it had a genuine profit. The enterprise still
returns less to the economy than it devours in resources…Until then it does not
create wealth; it destroys it." EVA corrects this error by explicitly recognizing that
when managers employ capital they must pay for it, just as if it were a wage.
If the shareholders expect, say, a 10% return on their investment, they "make
money" only to the extent that their share of after-tax operating profits exceeds
10% of equity capital. Everything before that is just building up to the minimum
acceptable compensation for investing in a risky enterprise.
In stock selection the EVA tool can be used in four distinct ways.
1. To measure how much shareholder value the firm has created in the past and
2. To determine investor expectations as they relate to the stock price.
Above all, EVA helps in overcoming the ambiguity of financial goals. Most
companies use a plethora of measures to express their financial goals and
objectiv
One of the earliest to mention the residual income concept was Alfred
Marshall in 1890. Marshall defined economic profit as total net gains less
the interest on invested capital at the current rate.
"... There is no profit unless you earn the cost of capital. Alfred Marshall said that
in 1896, Peter Drucker said that in 1954 and in 1973, and now EVA (economic
value added) has systematized this idea, thank God."
- Peter Drucker
"Companies that adopt EVA incentives increased their market-to-book value ratio
by nearly 0.6 more than that of non-EVA peer companies. That means for every
$1 billion in book value an EVA firm creates nearly $600 million more in market
value than the non-EVA peer companies."
"EVA based companies outperform their non-EVA peer companies by 9%, 12%, &
10%, one, two and three years, respectively, following adoption of EVA. Prior to
adoption of EVA, the EVA-based companies demonstrated no significant excess
performance relative to non-EVA peers."
"Unlike earnings or ROE or any of those other measures, EVA gets at what we're
really after: the creation of value by earning returns above our required cost of
capital across time."
"We don't look for companies with the highest EVA for our funds, but for
companies that can positively increase their EVA."
It has been shown that share price has a much higher positive correlation with
EVA than with any other measure of value.
"The EVA methodology explicitly addresses business and financial risk and
allows the investor to gauge the magnitude and sustainability of returns.
Moreover, this structure examines the three fundamental principles of value
creation: cash flow, risk, and sustainability of returns. Of all financial measures,
it best explains the creation of shareholder value."
- Al Jackson
"The EVA approach to equity analysis has become increasingly popular because
it more accurately reflects economic reality (as opposed to accounting reality)
when compared with many traditional valuation measures, such as earnings per
share (EPS), return on equity (ROE), and free cash flow ..."
- Steven G.Einhorn
"Economic Value Added (EVA) is a superior metric ... EVA has a higher
correlation with wealth creation than do EPS, ROE, or cash flow."
- Steven Milunovic
COMPANIES
COCO-COLA
Corporation Bank:
“To help us make all the short- and long-term decisions that affect our company
and help it to grow, we use a highly respected performance indicator,
measurement, and compensation system called Economic Value Added (EVA).”
There are various views with respect to whether traditional measures or value-
based measures influence change in share price.
There is a lot of academic and professional research undergoing these days with
the following question common to every research:
1) Calculating NOPAT(Net Operating Profit After Tax) using profit and loss
account.
2) Calculating invested capital using Balance Sheet.
3) Calculating the returns on the market using the indices ,which represent
the Market.
4) Extracting the risk free rate from sources.
5) Calculating cost of debt.
6) Calculating the cost of equity using CAPM model.
7) Using the above information ,calculating EVA.
1. Calculation of NOPAT:
The basic exemption of Stern Stewart is that second step can be adjusted
as per the convenience of the research person but the only condition is that the
same process has to be followed for all the years and all the companies under
research.
2. Calculation of WACC:
It refers weighted average cost of capital (equity and debt). WACC used in the
calculations is at book value of equity and debt. It is calculated as follows:
3. REVIEW OF LITRATURE:
Stern Stewart in 1990 has first studied this relationship with market data
of 618 U.S. companies. Stewart presents the results in his book "The
quest for value". Stewart has studied the relationship between EVA and
market value of the company and he has produced a list of companies’
EVA annually since 1982, its coverage is limited to the largest 1,000
companies.
EVA significantly impacts the market value added of a firm and that this wealth
effect stems from the company’s positive residual return on capital. He calculates
regression statistics between the MVA-to-capital and EVA-to-capital ratios from
the data of 983 firms.
Value-added measures are slightly but not significantly more correlated with
stock returns than traditional performance measures.
“Both measures correlate positively with stock returns and that the correlation is
slightly better than with traditional performance measures like return on assets
(ROA), return on equity (ROE) and return on sales (ROS).
They also find that firms with greater focus on their business activities have
significantly higher MVA than their less focused counterparts.
Lehn and Makhija conclude that their results suggest EVA and MVA to be
effective performance measures that contain information about the quality of
strategic decisions and serve as signals of strategic change.”
EVA is the most widely used Value-Based performance measure probably just
because it happens to be an easier concept compared to the others. In
implementing EVA, one of the most important things is to get the people in
organizations to commit to EVA and thereby also to understand EVA. Even as
easy concept as EVA seems to be quite hard to communicate down the
organization. That is why complicated measures do not work very well.
“Some Value-Based measures have been found to correlate better with share
prices than EVA and find that Cash Flow Return on investment (CFROI) explains
share price movements better than EVA. Of course EVA can also be modified in
order to avoid some accounting distortions and to correlate better with share
prices, but then we have almost as complicated measure as CFROI. The best
All the shareholder value metrics are said to be identical to discounted free cash
flow -method, so it is no wonder that we can relate the results of these metrics "to
the fourth decimal points". With the complicated shareholder wealth -measures it
is not always the toughest part to communicate these to people, but to calculate
these in day-to-day operations. E.g. CFROI calls for taking into account the
effects of inflation to asset values and this in turn takes time and resources.
“They advance the literature by ascertaining the relative weights that firms should
use in a realistic setting where they do not know all of the relevant attributes of
alternative performance measures a priori.
More surprisingly, they show that the apparently simplistic idea of comparing the
relative ability of alternative measures to explain stock returns is both
theoretically defensible and a reasonable representation of practice. Therefore,
firms contemplating the adoption of EVA would be well advised to begin with an
examination of EVA's R2 with its stock returns.”
Finally, there are no magic bullets that create value. Value creation is hard work
in competitive markets and almost always involves a trade off between costs and
benefits. Everyone has a role in value creation and it certainly is not the sole
domain of financial analysts. In fact, the value created by financial engineers is
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EVA & SHAREPRICE 2
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smaller and less significant than the value created by good strategic marketing,
production and personnel decisions.”
From the study of above mentioned research papers, one can understand that
there is only a confusion but not any clear idea regarding the usage or non-
usage of EVA in forecasting the share prices of the company.
Here is the research gap an the main objective behind this research
4. Research Methodology
The Sampling method used here is Simple Random Sampling. The companies
listed in the stock exchange are considered since the market prices can be
obtained. The companies in the Sensex are chosen because it is an ideal index
and it is considered to be a good proxy for the whole market. Also it is a
barometer that indicates the state and health of the economy.
At irregular intervals, the Bombay Stock Exchange (BSE) authorities review and
modify its composition to make sure it reflects current market conditions.
Therefore only 20 companies are considered for the research as the data of all
the 30 companies for all the five years is unavailable.
• Balance Sheet
• Profit and loss Account
• History of stock prices
• History of market index
• Risk free rate of return
• Corporate tax rate
• Balance sheet and Profit and loss Account are taken from the financial
statements of the sample companies from the database of Capital Market.
• History of stock prices and history of market index are downloaded from
database of Capital Market and Bombay stock exchange.
• Risk free rate of return of relevant years is taken from the RBI bulletin
As 365 days Treasury bill rate is considered to be the proxy for risk free
rate of return.
• Corporate tax rate is taken from the Indian annual budget statements and
KPMG survey 2006,
4.9 Hypothesis
t-statistic is used for testing the significance of an dependent variable over the
independent variable.
There are two methods of testing the relationship with the help of t-statistics.
They are
1. To compare the values of t- calculated with that of t- tabulated.
In this case if the calculated t-value is greater than that of table value null
hypothesis has to be rejected and alternate hypothesis has to be accepted.
TABLE 3: NOPAT
NOPAT is increased consistently increased and improved from year to year of
almost companies. There is some variations in case of Airtel, HUL, ONGC and
Ranbaxy.
TABLE 4: WACC
From the table it is concluded that weightage average cost of capital (WACC) of
the all companies during 2003 and 2004 is very low. WACC is around 0.02
during these years. But in 2004 WACC is increased drastically because of
increasing beta . In case of Infosys there is only equity fund employed and they
are known as debt free company.
Adjusted R Square:
ACC:
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EVA & SHAREPRICE 2
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Regression
Statistics
R Square 0.84438
Adjusted R
Square 0.792507
Regression
Statistics
R Square 0.801423
Adjusted R
Square 0.73523
The p- value in this case is 0.040067 which is less than 5%. Therefore
Alternate hypothesis is accepted.
As such there is relationship between EVA and share price
BHEL:
Regression
Statistics
R Square 0.50153
Adjusted R
Square 0.335373
Regression
Statistics
R Square 0.279687
Adjusted R
Square 0.039582
The p- value in this case is 0.3595 which is more than 5%. Therefore
Null hypothesis is accepted.
As such there is no relationship between EVA and share price.
Regression
Statistics
R Square 0.583084
Adjusted R
Square 0.444112
The p- value in this case is 0.132976 which is more than 5%. Therefore
Null hypothesis is accepted.
As such there is no relationship between EVA and share price.
Gujarat Ambuja
Regression
Statistics
→Small positive correlation. If EVA moves
by one, share price will move by 0.129 in the same
Multiple R 0.129352 direction.
AdjustedR
Square -0.31102
The p- value in this case is 0.835764 which is more than 5%. Therefore
Null hypothesis is accepted.
As such there is no relationship between EVA and share price.
HDFC Bank:
Regression
Statistics
R Square 0.856033
The p- value in this case is 0.02427 which is less than 5%. Therefore
Alternate hypothesis is accepted.
As such there is relationship between EVA and share price.
HDFC Finance:
Regression
Statistics
Multiple R 0.240021
R Square 0.05761
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Adjusted R
Square -0.25652
EVA & SHAREPRICE 2
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→Small positive correlation. If EVA moves by one, share price will move
by 0.24 in the same direction.
The p- value in this case is 0.697356 which is more than 5%. Therefore
Null hypothesis is accepted.
As such there is no relationship between EVA and share price.
Hindalco:
Regression
Statistics
R Square 0.003743
Adjusted R
Square -0.32834
The p- value in this case is 0.922156 which is more than 5%. Therefore
Null hypothesis is accepted.
As such there is no relationship between EVA and share price.
HUL:
Regression
Statistics
R Square 0.154279
Adjusted R
Square -0.12763
The p- value in this case is 0.513066 which is more than 5%. Therefore
Null hypothesis is accepted.
As such there is no relationship between EVA and share price.
Regression
Statistics
R Square 0.664294
Adjusted R
Square 0.552392
The p- value in this case is 0.092792 which is more than 5%. Therefore
ITC:
Regression
Statistics
R Square 0.000646
Adjusted R
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Square -0.33247
EVA & SHAREPRICE 2
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The p- value in this case is 0.967654 which is more than 5%. Therefore
Null hypothesis is accepted.
As such there is no relationship between EVA and share price.
L & T:
Regression
Statistics
Multiple R 0.839389
R Square 0.704574
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Adjusted R
Square 0.606099
EVA & SHAREPRICE 2
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→Large positive correlation. If EVA moves by one, share price will move
by 0.8394 in the same direction.
The p- value in this case is 0.075378 which is more than 5%. Therefore
Null hypothesis is accepted.
As such there is no relationship between EVA and share price.
M & M:
Regression
Statistics
R Square 0.627831
Adjusted R
Square 0.503774
MARUTI:
Regression
Statistics
R Square 0.021406
Adjusted R
Square -0.30479
The p- value in this case is 0.81438 which is more than 5%. Therefore
Null hypothesis is accepted.
As such there is no relationship between EVA and share price.
ONGC:
Regression
Statistics
Adjusted R
Square -0.33311
Ranbaxy:
Regression
Statistics
R Square 0.000168
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Adjusted R
Square -0.33311
EVA & SHAREPRICE 2
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→0.0168% of change in share price is due to change in EVA.
The p- value in this case is 0.983482 which is more than 5%. Therefore
Null hypothesis is accepted.
As such there is no relationship between EVA and share price.
Reliance industries:
Regression
Statistics
Multiple R 0.50152
R Square 0.251522
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Adjusted R
Square 0.002029
EVA & SHAREPRICE 2
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Reliance Energy:
Regression
Statistics
R Square 0.300323
Adjusted R
Square 0.067097
The p- value in this case is 0.33894 which is more than 5%. Therefore
Null hypothesis is accepted.
As such there is no relationship between EVA and share price
Wipro:
Regression
Statistics
R Square 0.467242
Adjusted R
Square 0.289656
• Investing in the market is becoming more and more risky as the beta of the
individual securities is increasing year by year.
• Majority of the companies are increasing their capital to meet the increased
expenses.
• As the market is becoming more and more risky, investors expectations are
increasing and therefore share prices of almost all the companies for almost all the
years showed an increasing trend.
This specifies that there is no relationship between EVA and share price.
Conclusion from the study:
This report explains the importance of using EVA as a tool for measuring financial
performance. The study reveals that there is no strong pattern of EVA of selected
companies during the period.
It is also observed that there is no strong relation between EVA and market
prices of the companies. Thus, it can be understood that investor do not give so
importance to EVA for its investment decision. Extensive study is required to
establish the influence of other factors like non-fund based income, spread,
deployment of funds, market price, etc. It is also expected that the usage of EVA
as a financial performance tool will also be more in India.
The study adds that EVA is the one of the measure, which can be used to
measure the performance of the company but it cannot be used to forecast the
share price of the company.
Suggestions for further research:
This research has a limited scope, that is only five years and the data of only
twenty companies is taken into consideration. These five years had showed a lot
of variations with respect to beta, invested capital, weighted average cost of
capital and share prices.
To overcome this limitation of the study, the sample size and the years of
consideration for the research has to be increased, so as to decrease the
variations with respect to the above mentioned variables.