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   Delhi Business Review ? Vol. 1, No. 1, Jan.2000 MARKET VALUE ADDED AND SHARE PRICE BEHAVIOUR AN EMPIRICAL STUDY OF BSE SENSEX COMPANIES M. Thenmozhi NVESTORS , world over, are currently demanding more shareholder value than just highreturns. Maximising shareholders value has always been the ultimate aim of every company.Investors are very keen in assessing the corporate financial performance that correlate withshareholders wealth particularly the market price of a share. Traditional performance measureslike return on investment, earnings per share, etc., have been used as the most important measureof shareholder value creation. But in the recent years, value based measures which measureperformance in terms of change in value have received a lot of attention. There are several valuebased measures such as Cash Flow Return on Investment (CFROI), Shareholder Value Added(SVA), Economic Value Added (EVA), Market Value Added (MVA) and Cash Value Added (CVA). This paper attempts to examine the relationship between share price and Market Value Added inrelation to other performance measures like Return on Investment, Return of Net Worth andEarnings per share with particular reference to BSE Sensex companies. MVA and its Characteristics Value based management and shareholder value analysis are well known concepts in the 1980’s,but there is now a renewed interest in them and also newer related concepts such as MVA.Market value added is the difference between the Company’s market and book value of shares.According to Stern Stewart, if the total market value of a company is more than the amount of capital invested in it, the company has managed to create shareholder value. If the market valueis less than capital invested, the company has destroyed shareholder value. Market Value Added = Company’s total Market Value – Capital Invested With the simplifying assumption that market and book value of debt are equal, this is the sameas Market Value Added = Market Value of equity – Book value of equity Book value of equity refers to all equity equivalent items like reserves, retained earnings andprovisions. In other words, in this context, all the items that are not debt (interest bearing or non-interest bearing) are classified as equity. Market value added (MVA  TM ) is identical in meaningwith the market–to–book ratio. The difference is only that MVA is an absolute measure andmarket–to–book ratio is a relative measure. If MVA is positive, that means that market–to–book ratio is less than one. According to Stewart, Market value added tells us how much value thecompany has added to, or subtracted from, its shareholders investment. Successful companiesadd their MVA and thus increase the value of capital invested in the company. Unsuccessfulcompanies decrease the value of the capital originally invested in the company. Whether a companysucceeds in creating MVA or not, depends on its rate of return. If a company’s rate of returnexceeds its cost of capital, the company will sell on the stock market with premium compared to I  Satender Kumar Joshi & Ravinder Goel  the original capital. On the other hand, companies that have rate of return smaller than their costof capital sell with discount compared to the original capital invested in company. Whether acompany has positive or negative MVA depends on the rate of return compared to the cost of capital.Market value added can also be defined in relation to Economic Value Added (EVA  TM ). EVAmeasures whether the operating profit is enough compared to the total cost of capital employed.Stewart defines EVA as the surplus of Net Operating Profit After Taxes (NOPAT) after adjustingfor capital cost, where NOPAT = Profit after depreciation and taxes but before interest costs andCapital Cost = Weighted average cost of capital X capital employed or EVA = (ROI – WACC) xCapital employed. He further defines the connection between EVA and MVA as : Market Value Added = Present Value of All future EVA By increasing EVA, a company increases its market value added or in other words increases thedifference between Company’s value and the amount of capital invested in it. The relationship of MVA with EVA has its implication on valuation. By rearranging the formula, market value of equity can be defined as : Market value of equity = Book value of equity + Present value of all future EVA. MVA is essentially the difference between the company’s current market value, as determined byits stock price, and its economic book value. For example, in the case of General Electric, whichwas the top U.S. performer at the end of 1994, the total market value of GE’s debt and equity atthat time was $101 billion. And since the adjusted book value of that capital was only $46 billion,GE’s MVA amounted to $55 billion.MVA is a far more revealing figure than a simple rise in market capitalisation, because the latterfails to consider the money investors put up. For example, if a company increased its marketcapitalization by Rs.500 crore over five years, but at the same time ploughed back Rs.600 crore inretained earnings, it actually has destroyed Rs.100 crore of shareholder wealth.For instance, the MVA of Infosys Technologies Ltd for the year ending 31 st March 1994 to 1998 isgiven below :(Rs. In lakhs)19941995199619971998 a. Market value of equity 19,101.50 34,842.00 35,567.10 73,104.17 2,96,342.20b. Value of Debt. __ 633.91 426.06 __ __ c. Enterprise value (a+b) 19,101.50 35,475.91 35,993.16 73,104.17 2,96,342.20d. Average capital employed 1,786.87 4,801.44 7,644.80 9,846.75 14,289.67e. MVA (c-d) 17,314.63 30,674.47 28,348.36 63,257.42 2,82,052.53 From the above it could be observed that the MVA has increased tremendously and that isreflected in the increase of the share price of Infosys Technologies in the stock market. Thus,investors should focus on MVA instead of market capitalisation, as market capitalisation is amisleading indicator of success. For instance, the 1994 results of CocoCola and IBM , as givenbelow, indicate that on the basis of market capitalisation IBM may be perceived to be doing welland only $9 billion it is behind Cococola. But MVA shows that it is far behind Cococola as it hasdestroyed shareholders wealth to the tune of $17 billion.   Delhi Business Review ? Vol. 1, No. 1, Jan.2000 CocoColaIBM Market capitalisation$61 billion$52 billionInvestor’s Capital$ 8 billion$69 billion MVA $53 billion$ 17 billion Objectives ? An attempts is made in this study to (i) compute the MVA and MVA per share of BSEsensex companies(ii)examine the relationship between MVA and other traditionalmeasures of corporate performance. ? examine the relationship of share price with MVA, MVAPS, EPS, ROCE, and RONW. Data and Methodology  The sample comprises 27 BSE sensex companies for a period of three financial years between1997 and 1999. The required financial data has been collected the from a database package‘Capitaline 2000’. The Bombay Stock Exchange (BSE) share prices of the Sensex Companies hasbeen collected from Capitastock Ole. The values of ROCE, RONW and EPS have been taken as given in the database while MVA hasbeen computed using the Stern Stewart formula, where MVA is difference between the marketvalue of equity and book value of equity. The MVA per share has been computed by dividing theMVA by the total number of shares. The share price of the 27 scrips has been taken as the average of the high, low and opening andclosing values of that financial year. Since no huge transitions had occurred in the trends of stockprices over the period considered, the fluctuations are not far off from the obtained average value. The relationship between MVA and other traditional measures was examined using Pearson’scoefficient of correlation. Stepwise Regression Analysis has been used to examine the relationshipof MVA, MVAPS, EPS, ROCE & RONW with share price. The data has been computer analysedusing SPSS package and MS-Excel. Limitation  The limitations of this study are that it is based on only 3 year data and the sample comprisesonly the BSE sensex companies. The impact of performance measures such as EPS, ROCE,RONW and MVA on stock price variation has been measured while there are other variables likedividend per share, price-earnings ratio, etc., which have not been considered for analysis as thepurpose is to only find out if MVA should also be considered along with other performance measuresor not. Moreover, the association of EVA as a performance measures has also not been examined. Results MVA and Traditional measures of performance  The MVA of the selected companies shows that (as given in Table 1), during the year ending1999, 18 companies have positive MVA. Hindustan Lever, ITC, TELCO, MTNL, Bajaj Autoand BHEL are the top 6 companies having high MVA while the other companies have lowMVA. 9 companies have negative MVA and have destroyed shareholder value. The worstbeing SAIL, followed by ACC, IPCL and Arvind Mills.During the financial year 1998, 22 companies have shown positive MVA while 5 companieshave negative MVA. TELCO, HLL, ITC, MTNL, Reliance, BHEL and Bajaj Auto are the top7 companies with high MVA.  Satender Kumar Joshi & Ravinder Goel  A KPMG – BS study (1998) of 100 top companies on EVA, MVA, PAT and Sales criterionshowed that ONGC, Hindustan Lever, Bajaj Auto, VSNL and BPCL are the front runners increating shareholder value (60 in number) and SAIL, TISCO, L&T and Essar Steel in destroyingshareholder value (38 in number). 24 companies have destroyed shareholder value by reportingnegative MVA.Correlating the traditional measures with MVA show that the relationship in positive but itis very low and moderate with EPS (0.306), RONW (0.4823) and ROCE (0.4335). This may bedue to the fact that the very basic definition MVA separates it from the other three measuresand the traditional measures do not reflect the real value of shareholders. Hence, MVA hasto be measured to have an idea about shareholder value.In order to have a better inference, the MVA per share (MVAPS) which is a relative measure,was calculated and the relationship of MVAPS to EPS, RONW & ROCE were ascertainedthrough correlation analysis. The results show thatMVAPS & EPSr = 0.1810MVAPS & ROCEr = 0.7716MVAPS & RONWr = 0.7636 There is low and moderate association between MVAPS and EPS but there is high associationbetween MVA & ROCE and MVAPS & RONW.A number of studies have been done by Stern Stewart to see which measures of performanceare most closely linked not with market value but with MVA. Measures like earnings, EPSand earnings growth all have some trival relationship to MVA. They found that MVA isexplained by ROE only to the extent of 35%, while EPS explain 18%, dividend growth 16%,sales growth 9% and EVA 50%. The reason for greater strength of correlation with EVA is,EVA, unlike other measures, corrects the accounting distortions and specifies a required rateof return that must be earned on capital employed.In the KPMG-BS (1998) study the relationship between the ranks on four criterion variables(Economic Profit (EP), PAT, Sales, MVA) for 98 companies were studied by using Spearman’srank correlation coefficient. The result show that rank correlation of EP and PAT, EP andMVA are statistically significant, but it is not substantial. There is high degree of positivecorrelation between PAT and MVA. However, the variation explained is quite low.EP & PAT=Rs.0.246EP & MVA=Rs.0.360Sales & MVA=Rs.0.441PAT & MVA=Rs.0.666 MVA and share price behaviour On examining the relationship between MVA and share price and MVAPS and share price itis found that share price is highly correlated to MVAPS (r=0.8779) while it is moderatelycorrelated to MVA (r=0.4991). Hence, MVAPS is a better measure for examining therelationship with share price than MVA.In order to find out which of the performance measures influence share prices, a step wiseregression analysis was performed. This method was chosen, so that only those variableswhich influence the share prices will be included in estabilshing the regression model.Regression analysis of share prices with EPS, RONW, ROCE and MVA (Table 2) shows thatonly 3 variables EPS, MVA and ROCE are included in the final analysis and they collectivelyexpalin a variance of 71.9% of the share price and are statistically significant at 0.01 level of significance. However, the most influencing variable is ROCE (b = 0.555) followed by EPS
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