Markets are sniffy about a pallid current performance and a metric like EVA makes a scathing attack on the firm's ability to master two conflicting requirements, the ability to return capital to investors while simultaneously being able to fuel the capital needs of a growing business.
I am intrigued further on this topic and two of the recent books I have read, the seminal 'Value & Capital' by John Hicks and 'Liquidity: Inside & Outside' by Jean Tirole gives me some ammunition to take my thinking forward.
Hicks used the 'dynamic economy' for the first time in Economics while Tirole has been a Titan in the field of Industrial Economic Theories, where he dealt on the topic of multiple liquidity shocks when firms expand as large doses of capital injection happens. While on the topic of EVA, we cannot exclude the role played by liquidity shocks for firms in high demand of capital under different convergent scenarios of capital constraints during expansion. These liquidity shocks have market fall outs and strategies must be re-oriented to deal with them.
These topics are relevant for a company that is growing at a frenetic pace as it embarks on an expansion curve on the back of fixed nature of capital investment. To be able to return capital while on its ascendancy becomes a crucial point of challenge and market measures like EVA could be very punishing.
EVA per se is on a static economy; it takes one snapshot and gives the information of past performance. Market value added on the other hand is dynamic; it gives the NPV of future cash flows or the Net present value of future EVAs.
Take for example a company with an EVA as (about) negative $1 Billion, and Market Value added currently (about) negative $2 Billion. These two numbers makes me delve deeper into the static Vs the dynamic values. For this company the market makes a judgment that the company based on its current performance and future projections would not be able to improve on its EVA going forward, thus the present value of its future EVAs is far worse than the EVA of its last performance year.
But how does the market judge the future, it has only the current treadmill with the current performance. Well, it also has the recent trends to look at. Alcoa offers a classic example.
Alcoa EVA was negative $700 Million last year, but it has a $1Billion positive MVA. This swing in valuations stem from its very positive portfolio transformation program that it could sell at the market place.
I compared Alcoa, where the static vs the dynamic is rather better, where the dynamic moved to the positive territory versus the static. And what stood out is that their very current actions on portfolio transformation made the market look at the future much more positively, taking the valuation several notches up. Currency of events has a far higher influence on the dynamic measure, as in this example.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.