Glossary
Key Terms Glossary
Ranking system (Percentile rating): In the analysis, the values of each indicator (Sales Growth Rate, EVA Margin, EVA Momentum, Future Growth Reliance, NOPAT Multiple, Performance Score, and Valuation Score) are not presented in absolute terms but according to a ranking within the S&P 500 index (e.g., 50th percentile means 50 points, 90th percentile means 90 points, etc.). The full range of the scale can take values between 0 and 100. The EVA framework's metrics system is ideally suited to apply ranking in this way and to rank companies on this basis. Each indicator is suitable for absolute comparison; a higher value is always better, so the ranking is objective.
Performance Score: the arithmetic average of the EVA Momentum’s percentile rank, the EVA Margin's percentile rank, and the Sales Growth Rate's percentile rank over the period. Averaging is done for Current, 3-year average, and 5-year average periods.
Valuation Score: the arithmetic average of Future Growth Reliance's percentile rank and the NOPAT Multiple's percentile rank over the period, averaged over the Current, 3-year average, and 5-year average periods.
Super Stocks Score: the arithmetic average of the EVA Momentum’s percentile rank, the EVA Margin's percentile rank, the Sales Growth Rate's percentile rank, the Future Growth Reliance's percentile rank, and the NOPAT Multiple's percentile rank over the period.
Time frames: In the analysis, the current value, the 3-year average value, and the 5-year average value are compared, from which it can be concluded how the current value corresponds to the past average values. This will help test trends; past performance is no guarantee of future performance.
Sector view: Data at the sector level show the average percentile values of companies in a given sector.
Competitors view: The scatter plot of competitors includes all companies in a given sector in the S&P 500 index, with the analyzed company highlighted in a red circle.
Valuation chart: The valuation chart shows Morningstar's historical valuation, representing the relationship between what Morningstar considers fair value and the stock's market price. An area highlighted in orange indicates the stock is overvalued, and an area highlighted in blue indicates the stock is undervalued.
EVA Radar chart: Display the percentile value of the five metrics used on a radar chart on a scale of 0 to 100. These five metrics are EVA Margin, EVA Momentum, Sales Growth Rate, Future Growth Reliance, and NOPAT Multiple.
Definitions
This Definitions section is based on Bennett Stewart's book Best Practice EVA and the ISS EVA professional publications.
NOPAT is net operating profit after taxes. It is operating profit before any interest or financing charges are deducted, measured net of period charges for depreciation and amortization, and after taxes computed using a smoothed standard tax provision, net of the cost of capital saved from deferring taxes, and after corrective adjustments to remedy accounting distortions.
Capital is net business assets. It is all assets used in business operations, net of trade funding from accounts payable and accrued expenses. It also equals the total debt and equity raised from investors or retained from earnings.
Cost of capital (COC) is the minimum rate of return required to compensate lenders and shareholders for risk. It is not an actual cash cost that a company must pay or that accountants record. It is an invisible but genuine opportunity cost—the cost to investors of giving up the opportunity to invest their capital elsewhere.
Capital charge is NOPAT needed to earn the cost-of-capital return on the firm’s capital. It is determined by multiplying the cost of capital by the average amount of capital in the business over the period. It is how large NOPAT would be to enable the firm to pay interest on its debts after tax and leave a profit remainder, giving its shareholders a minimum acceptable return on the equity they’ve put in the firm.
Sales (Revenue): provide a top-line measure of performance. There can be no sustained increase in EVA without sustained sales growth (constant, sustainable year-on-year revenue growth). Customer satisfaction, repeat business, innovation, and development are essential for EVA creation.
EVA (economic value added) is NOPAT minus capital charge (NOPAT – Capital charge). It measures the firm’s economic profit after deducting all costs, including the cost of giving the firm’s investors a total, fair, and competitive return on their investment in the business. EVA consolidates income efficiency, asset management, profitable growth, and strategic retrenchment into a comprehensive net profit score. All growth that produces returns higher than the cost of capital will cause EVA to increase, even if existing margins or rates of return are diluted.
EVA Margin (EVA / Sales) is the ratio of EVA to sales; it is the firm’s actual economic profit margin covering income efficiency and asset management. Unlike EBIT and EBITDA margins, which are inflated by the margin requirements of capital-intensive businesses, EVA Margins are not biased in favor of capital-intensive business models because any added capital is a cost to the EVA Margin. As a result, even firms that differ as much as the capital-mongering chip maker Intel and the incredibly capital-lean consumer staples retailer Wal-Mart can be meaningfully compared regarding their EVA Margins, whereas they are incomparable on other barometers.
It is more effective to consider increasing EVA by looking for ways to improve it and drive profitable sales growth at a positive EVA Margin. This goal ultimately leads to EVA Momentum, which supersedes even the EVA Margin as a ratio measure of total performance progress from all sources.
EVA Momentum (Δ EVA / Sales) is the change in EVA divided by prior-period revenues. It is the size-adjusted growth rate in economic profit. It is the ideal overall summary measure of performance progress. The statistics can grade overall performance and benchmark with peers. It is the only performance ratio with a clear line between good and bad performance. That line is zero EVA Momentum. If EVA Momentum is positive, EVA has increased; if it is negative, EVA has declined.
Market value is the value of the firm’s debt and equity capital, given its share price and net of excess cash, assuming that the liabilities' book value approximates their market value. The debt capital consists of all interest-bearing short- and long-term debt and capital leases, the estimated present value of rents (from capitalizing operating rents at a multiple), and the postretirement net balance sheet funding liability (net of prepaid postretirement assets and accumulated other comprehensive income [AOCI], and net of tax).
MVA (market value added) is the firm’s market value minus its capital. MVA shows, as no other measure can show, how successful management has been at allocating, managing, and redeploying scarce resources to maximize the enterprise's net present value and thus maximize the owners' wealth. Increasing MVA, even if only to make a negative MVA less damaging, is the real test of corporate success over time.
CVA (current value added) is the value from capitalizing the firm’s current EVA in perpetuity. It is the MVA, or franchise value that the company would have if the firm could sustain its most recent EVA forever and could not grow it any further.
FVA (future value added) is the present value of the projected growth in EVA over the prevailing level. The market’s estimate for FVA is derived simply by subtracting CVA from MVA—from removing the MVA portion due to capitalizing the current EVA in perpetuity. The larger the FVA remainder, the more the market registers confidence that management has positioned the company for sustained growth in EVA (and vice versa).
NOPAT Multiple (MV / NOPAT) is the market value ratio to net operating profit after taxes. Research by Bennett Stewart’s company shows that NOPAT multiples better explain and predict stock prices than cash flow multiples do. Although the NOPAT multiplier is included, it is difficult to isolate how much of the company's market value depends on EVA growth and how much of its risk is involved. Therefore, it is less efficient than FGR.
FGR (future growth reliance) is the ratio of FVA to market value (market-implied value of future growth in EVA) / MV). It is the percent proportion of the firm’s market value that is derived from, and depends on, growth in EVA. The greater the reliance, the more confidence the market places on the company’s ability to rebound from a cyclical downturn or strategically drive EVA expansion.