FRAMEWORKANOVERVIEWBASTUDENTS.ppt

BCGSVALUEMANAGEMENTFRAMEWORKANOVERVIEWFORMBASTUDENTS,ByRawleyThomasDirectorofResearch,TheBostonConsultingGroup200SouthWackerDriveChicago,Illinois60606312-627-2618Thomas.RawleyBCG.com,WHATGETSMEASUREDGETSDONE,TraditionalValuationTechniquesVersusBCGsValuationFramework,TraditionalValuationTechniquesForecastnominalcashflowsbyestimatingPsubtractdebttodetermineequityvaluationTestmodelvaluesagainstactualstockpricesforthousandsoffirmsfor10-40yearsacrossmanycountries;refine,refine,refine,MANYASSETSFOLLOWTHESAMEUSEFULOUTPUTPATTERNASACAR.,ConstantDollarLevelAnnuity,EconomicLife,LikelyActualOutput,OutputDeclinewithStraightLineDepreciation,ISSUESWITHTRADITIONALRETURNMEASURES,(*)Economicdepreciation=amountofannualsinking-fundpaymentearningCOCrequiredtoreplaceassets($357=0.1/1.114-1)(12,000-2,000),Investmentprofileofanewplant,Subsequentannualmeasurement,Yr1Yr6Yr12Income843843843Depreciation714714714Cashflow1,5571,5571,557Cashinvested12,00012,00012,000Bookcapital11,2867,7163,432ROCE(%)7.510.924.6ROGI(%)131313CFROI(%)101010,ROCE=Income/bookcapitalROGI=Cashflow/cashinvestedCFROI=(Cashflow-economicdepreciation(*)/cashinvested,Yr1Yr6Yr12NOPAT(1)843843843Bookcapital(2)11,2867,7163,432Costofcapital(3)x10%x10%x10%Capitalcharge(4)1,129772343EVA(1-4)(286)71500Cashflow(6)1,5571,5571,557Cashinvested(7)12,00012,00012,000Costofcapital(8)x10%x10%x10%Capitalcharge(9)1,2001,2001,200Economicdep.(*)(10)357357357CVA(6-9-10)000,VALUE-ADDEDMEASURESREFLECTRETURN,COSTOFCAPITALANDSIZEReturnonNewPlantMeasuredOverTime,(*)Economicdepreciation=amountofannualsinkingfundpaymentearningCOCrequiredtoreplaceassets($357=0.1/(1.114-1)(12,000-2,000),Investmentprofileofanewplant,TrackingtheSampleof1970Companiesthroughtime,TrackingtheSampleof1980Companiesthroughtime,TrackingtheSampleof1987Companiesthroughtime,Notetheaverages-7.00onCorporateTaxRateCorrelationbetweenInflationandTaxRates:0.00%,CFROIActual,R2=0.76,TOSMOOTHECONOMICCYCLES,BUTINCORPORATESTRUCTURALSHIFTS,BCGSVALUATIONMODELASSUMESCURRENTCFROILEVELSFADETOWARDTHE5-YEARPASTMEDIANOFTHEDISCOUNTRATESAMPLEATA10%RATE,AnnualCFROIs,5-YearPastMedianCFROIs,BCGSVALUATIONMODELANTICIPATESTHATTHEGROSSASSETGROWTHRATEOFALLCOMPANIESINTHEUSAFADETOWARDTHELONGTERMECONOMYAVERAGE,AnnualGDPGrowthRates,3.2%CompoundedAnnualGrowthRateinGDPfrom1950-1996,UnlikeCFROIs,wherecleartrendsareevident,theredoesnotappeartobeacleartrendingrowthratesfortheeconomy.Consequently,alongtermaveragesmoothsouttheannualfluctuationswithnolossininvestoranticipatedtrend.,Price=DiscountedPresentValueofExpectedFutureNetCashFlows,THEINVESTORSDISCOUNTRATEISTHATRATEWHICHEQUATESTHEPRESENTVALUEOFCASHFLOWSFROMBCGSVALUATIONMODELTOTHEMARKETVALUEOFDEBTANDEQUITY,MarketValueofDebtandEquityofSMayRepresentaProxyforOtherEffects,DiscountRatesBasedon1996DiscountRateSampleof279S&PIndustrials,R2=0.91,CFROIEffects,CFROISNORMALLYEXCEEDTHEMARKETDERIVEDDISCOUNTRATES1996DISCOUNTRATESAMPLE,CFROIs,MarketDerivedDiscountRates,Differences,Politics/PoliciesChange,CFROISNORMALLYEXCEEDTHEMARKETDERIVEDDISCOUNTRATES,Eventhoughmanyeconomistsbelievethatallreturnsmustconverge,inahealthycapitalisteconomy,CFROIsonhardassetswillexceedinvestorrequiredreturnsonfinancialassetsmostofthetime,because:ContinuousnewentrepreneurialinnovationspreventCFROIsfromconvergingcompletelytopromisedfinancialreturns(imperfectarbitrage)andEntrepreneursmustberewardedwithgreaterreturnstoassumethegreaterdispersionandhigherriskoflossassociatedwithCFROIsonilliquidhardassetscomparedtofinancialreturnsonmarketable,liquidfinancialassets,ProducerPriceIndex%Change,GNP/GDPDeflator%Change,InflationaryExpectations,0.0%BaseRate1950-19802.6%BaseRate1981-1996,InflationaryExpectationsbasedon0-2.6baseratesfollowactualinflationmoreclosely,butavoidthesharpvolatilityofactualPPIandGNP/GDPannualinflation.,2.48,Note:thebaserateisdefinedastheafter-investortax,afterinflationrequiredreturnonGovernmentlongtermbonds.,BCGCALCULATESINFLATIONARYEXPECTATIONSBYSUBTRACTINGTAXPREMIUMSANDABASERATEFROMLONGTERMGOVERNMENTBONDYIELDSUSA-1950-1997,MARKETDERIVEDNOMINALEQUITYRATESCOMEFROMMARKETDERIVEDREALEQUITYRATESPLUSTHECOMPOUNDEDEFFECTOFINFLATIONARYEXPECTATIONS,MarketDerivedNominalEquityRate,9.17,6.53,2.48,MarketDerivedRealEquityRate,InflationaryExpectations,THEEQUITYRISKPREMIUMHASDECLINEDTOTHE2-3%RANGE,RiskPremiumDifferences,MarketDerivedNominalEquityRate,NominalLongTermGovernmentBondRate,2.66,RISKCONCEPTSANDMEASUREMENT,CAPM,MarketDerived,Investorsseektoavoidpricevolatilityrelativetothemarket.,Investorsseektoavoidlossesfromunanticipatedmajorevents.,MajorEventsBankruptcy(Leverage)UnanticipatedInflationGovernmentInterventionGovernmentOwnershipVotingRightsonKeyChangesAssetAge,ArbitragePricingTheory(APT)postulatesotherriskfactors:InterestRatesOilPricesPrice/EquityBookSize,NAIVEBELIEFSINCORRECTLYASSUMECOSTSOFDEBTANDEQUITYDONOTVARYWITHCAPITALSTRUCTURE.,CostofEquity,CostofDebt,After-Corporate-Tax,WeightedAverageCostofCapitalAfter-Corporate-Tax,Note:NOTBasedonValidTheoryorEmpiricalEvidence,BCGEMPIRICALWORKCONFIRMSINCREASINGREALCOSTSOFDEBTANDEQUITY,ACCORDINGTOTRADITIONALTHEORY,Equity,WeightedAverage,DebtAfter-Tax,Source:BCGDatabaseandEmpiricalResearchon63ValueLineIndustries-1995,Toourknowledge,noonehaspublishedempiricalresultslikethesebecauseofthesignificantinaccuraciesinthetraditionalestimationprocedurestypicallyused.BCGeliminatesmuchoftheseinaccuraciesthroughourfadingCFROIvaluationmodel.Evenwiththeseinaccuracieseliminated,thesecostofcapitalcurvesareprobablynotaccurateenoughforpreciseoptimumcapitalstructureworkonindividualfirms.Thisisduetoremainingnoiseinthedataandnosize,entrenchment,andassetrestructuringfunctionsbuiltintoourcurrentvaluationmodel.However,theseempiricalresultscanbeemployedtoavoidthemisperceptionthatcostsofequityandtotalcapitaldonotchangesignificantlywithchangesinleverage.RawleyThomas-DirectorofResearch,Lineofbestfitbasedonminimizingabsolutedeviationsofapowercurve(toreduceinfluenceofoutliers)andconstrainedtopassthroughresultsforSampleF,6.03+35.14(D/C)2.42,2.38+2.69(D/C)1.86,PRELIMINARYHOLTDISCOUNTRATERESEARCHMARKETDERIVEDREALCOSTOFEQUITYCORRELATIONCOEFFICIENTS1990,220Companies,15%FadeofCashFlowstoCorporateAverage,Note:Randomsampleof220nonfinancialindustrialcompanies,drawnfromover6,000,Plantageandlife(inflationadjustmentfactor),Plantlife,Dividendyield,Size(LN-currentdollargrossinvestment),Debt/totalcapitalatmarket,Industryrisk(governmentintervention?),CompanyBeta(valueline),UnleveredBeta,NotethesmallcorrelationwithBeta.Thissmall1%R2withBetasuggestsre-evaluationoftraditionalriskconcepts.,BOTHCFROIANDTSRFOLLOWSTABLEPARETIANDISTRIBUTIONSWITHINFINITEVARIANCESANDSIMILARPEAKEDNESS.,Peakedness=1.4912.1standarderrorsawayfrom2(Gaussian),Peakedness=1.458.8standarderrorsawayfrom2(Gaussian),Competitivepressuresforcereturnsdown,NumberofFirms,Investorpressuresforcereturnsup,KEYCONCLUSIONSThedistributionshereare8.8to12.1standarderrorsawayfromGaussianNormal.Forthesedistributions,variancedoesnotexist.Varianceisinfinite.Therefore,traditionalCAPMmeasuresofriskdonotexist.Theseresultssuggestrisktheoryshouldberevisedtoreflectactualdistributionsandthepossibilitythatinvestorsseektoavoidtheriskoflossinthefattailsofthedistributions,notdispersionrisk.,CONFLICTINGPERFORMANCESIGNALSCANCAUSEPROBLEMS,MostmanagementsuseIRRorNPVfornewprojectsandplansMostmanagementsuseaccountingratios(ROE,ROCE,RONA)orearningsgrowthforexistingbusinessesThetwotypesofmeasuresarefundamentallyinconsistentandcanleadtopoormanagementdecisionsForconsistencyandeconomicvalidity,useameasureliketotalshareholderreturntoevaluateprojectandoverallcompanyperformance,FOCUSONCFROIREMOVEDREINVESTMENTBIAS,ENCOURAGEDECONOMICBEHAVIORANDINCREASEDVALUE,Percentage,CampbellSoupCo.,Year,ROCE,CFROI,TSR/index1008386127135151167167158227239269252,AGINGPLANTTRAP,Percentageperyear,Year,NominalRONAhurdlerate,ForecastRONA,Realdiscountrate,ForecastCFROI,NEWPLANTTRAP,Percentageperyear,Year,Oldplant,RONA,Realdiscoun