Valuation

Measuring and Managing the Value of Companies

Tim Koller, Marc Goedhart, David Wessels

• Publisher: Wiley
• Year: 2020
• ISBN:
  9781119610922
• Edition: 7
• Topic: Negocios y empresa
• Subtopic: Inversiones y valores

McKinsey & Company's #1 best-selling guide to corporate valuation—the fully updated seventh edition

Valuation has been the foremost resource for measuring company value for nearly three decades. Now in its seventh edition, this acclaimed volume continues to help financial professionals around the world gain a deep understanding of valuation and help their companies create, manage, and maximize economic value for their shareholders.

This latest edition has been carefully revised and updated throughout, and includes new insights on topics such as digital, ESG (environmental, social and governance), and long-term investing, as well as fresh case studies.

Clear, accessible chapters cover the fundamental principles of value creation, analyzing and forecasting performance, capital structure and dividends, valuing high-growth companies, and much more. The Financial Times calls the book "one of the practitioners' best guides to valuation."

This book:

• Provides complete, detailed guidance on every crucial aspect of corporate valuation
• Explains the strategies, techniques, and nuances of valuation every manager needs to know
• Covers both core and advanced valuation techniques and management strategies
• Features/Includes a companion website that covers key issues in valuation, including videos, discussions of trending topics, and real-world valuation examples from the capital markets

For over 90 years, McKinsey & Company has helped corporations and organizations make substantial and lasting improvements in their performance. Through seven editions and 30 years, Valuation: Measuring and Managing the Value of Companies, has served as the definitive reference for finance professionals, including investment bankers, financial analysts, CFOs and corporate managers, venture capitalists, and students and instructors in all areas of finance.

Part One
Foundations of Value

1
Why Value Value?

The guiding principle of business value creation is a refreshingly simple construct: companies that grow and earn a return on capital that exceeds their cost of capital create value. Articulated as early as 1890 by Alfred Marshall,¹ the concept has proven to be both enduring in its validity and elusive in its application.

Nevertheless, managers, boards of directors, and investors sometimes ignore the foundations of value in the heat of competition or the exuberance of market euphoria. The tulip mania of the early 1600s, the dot-coms that soared spectacularly with the Internet bubble, only then to crash, and the mid-2000’s real estate frenzy whose implosion touched off the financial crisis of 2007–2008 can all to some extent be traced to a misunderstanding or misapplication of this guiding principle.

At other moments, the system in which value creation takes place comes under fire. That happened at the turn of the twentieth century in the United States, when fears about the growing power of business combinations raised questions that led to more rigorous enforcement of antitrust laws. The Great Depression of the 1930s was another such moment, when prolonged unemployment undermined confidence in the ability of the capitalist system to mobilize resources, leading to a range of new policies in democracies around the world.

Today many people are again questioning the foundations of capitalism, especially shareholder-oriented capitalism. Challenges such as globalization, climate change, income inequality, and the growing power of technology titans have shaken public confidence in large corporations.² Politicians and commentators push for more regulation and fundamental changes in corporate governance. Some have gone so far as to argue that “capitalism is destroying the earth.”³

Many business leaders share the view that change is needed to answer society’s call. In August 2019, Business Roundtable, an association of chief executives of leading U.S. corporations, released its Statement on the Purpose of a Corporation. The document’s 181 signers declared “a fundamental commitment to all⁴ of our stakeholders.”⁵ The executives affirmed that their companies have a responsibility to customers, employees, suppliers, communities (including the physical environment), and shareholders. “We commit to deliver value to all of them,” the statement concludes, “for the future success of our companies, our communities and our country.”

The statement’s focus on the future is no accident: issues such as climate change have raised concerns that today’s global economic system is shortchanging the future. It is a fair critique of today’s capitalism. Managers too often fall victim to short-termism, adopting a focus on meeting short-term performance metrics rather than creating value over the long term. There also is evidence, including the median scores of companies tracked by McKinsey’s Corporate Horizon Index from 1999 to 2017, that this trend is on the rise. The roots of short-termism are deep and intertwined, so a collective commitment of business leaders to the long-term future is encouraging.

As business leaders wrestle with that challenge, not to mention broader questions about purpose and how best to manage the coalescing and colliding interests of myriad owners and stakeholders in a modern corporation, they will need a large dose of humility and tolerance for ambiguity. They’ll also need crystal clarity about the problems their communities are trying to solve. Otherwise, confusion about objectives could inadvertently undermine capitalism’s ability to catalyze progress as it has in the past, whether lifting millions of people out of poverty, contributing to higher literacy rates, or fostering innovations that improve quality of life and lengthen life expectancy.

As business leaders strive to resolve all of those weighty trade-offs, we hope this book will contribute by clarifying the distinction between creating shareholder value and maximizing short-term profits. Companies that conflate the two often put both shareholder value and stakeholder interests at risk. In the first decade of this century, banks that acted as if maximizing short-term profits would maximize value precipitated a financial crisis that ultimately destroyed billions of dollars of shareholder value. Similarly, companies whose short-term focus leads to environmental disasters destroy shareholder value by incurring cleanup costs and fines, as well as via lingering reputational damage. The best managers don’t skimp on safety, don’t make value-destroying decisions just because their peers are doing so, and don’t use accounting or financial gimmicks to boost short-term profits. Such actions undermine the interests of all stakeholders, including shareholders. They are the antithesis of value creation.

To dispel such misguided notions, this chapter begins by describing what value creation does mean. We then contrast the value creation perspective with short-termism and acknowledge some of the difficulties of value creation. We offer guidance on reconciling competing interests and adhering to principles that promote value creation. The chapter closes with an overview of the book’s remaining topics.

What Does It Mean to Create Shareholder Value?

Particularly at this time of reflection on the virtues and vices of capitalism, it’s critical that managers and board directors have a clear understanding of what value creation means. For value-minded executives, creating value cannot be limited to simply maximizing today’s share price. Rather, the evidence points to a better objective: maximizing a company’s collective value to its shareholders, now and in the future.

If investors knew as much about a company as its managers do, maximizing its current share price might be equivalent to maximizing its value over time. But in the real world, investors have only a company’s published financial results and their own assessment of the quality and integrity of its management team. For large companies, it’s difficult even for insiders to know how financial results are generated. Investors in most companies don’t know what’s really going on inside a company or what decisions managers are making. They can’t know, for example, whether the company is improving its margins by finding more efficient ways to work or by skimping on product development, resource management, maintenance, or marketing.

Since investors don’t have complete information, companies can easily pump up their share price in the short term or even longer. One global consumer products company consistently generated annual growth in earnings per share (EPS) between 11 percent and 16 percent for seven years. Managers attributed the company’s success to improved efficiency. Impressed, investors pushed the company’s share price above those of its peers—unaware that the company was shortchanging its investment in product development and brand building to inflate short-term profits, even as revenue growth declined. Finally, managers had to admit what they’d done. Not surprisingly, the company went through a painful period of rebuilding. Its stock price took years to recover.

It would be a mistake, however, to conclude that the stock market is not “efficient” in the academic sense that it incorporates all public information. Markets do a great job with public information, but markets are not omniscient. Markets cannot price information they don’t have. Think about the analogy of selling an older house. The seller may know that the boiler makes a weird sound every once in a while or that some of the windows are a bit drafty. Unless the seller discloses those facts, a potential buyer may have great difficulty detecting them, even with the help of a professional house inspector.

Despite such challenges, the evidence strongly suggests that companies with a long strategic horizon create more value than those run with a short-term mindset. Banks that had the insight and courage to forgo short-term profits during the last decade’s real-estate bubble, for example, earned much better total shareholder returns (TSR) ...