HOW TO IMPROVE COMPANY VALUE
Posted on February 2, 2011
The goal of a business leadership team is to increase company value, but this is easier said than done. It helps - a lot - to break value creation down into actionable goals that managers and employees can understand and strive toward. This article series is aimed at helping you do this effectively and, thereby, ensuring untold fame and fortune.
First, let's break value creation down into its components - we'll call these value drivers. There are three primary value drivers: Profit Margin, Asset Productivity, and Growth. Let's look at each one in turn.
Profit Margin: To be specific, you want to look at Operating Margin percentage (i.e. Operating Profit/Revenue). This reflects the portion of revenue that remains as profit after paying operating costs, such as manufacturing costs, R&D, sales, etc. These are the funds from which you will pay investors (an obvious component of company value).
Asset Productivity: This term refers to the amount of Revenue that you generate from each dollar invested into Operating Assets (i.e. Revenue/Operating Assets). The importance of this metric is a bit less intuitive, but believe me, you need to get it. Here's why: The first chunk of profit that you make adds no incremental value to shareholders; it just pays the minimal "rent" on the money that they have sunk into your equipment and office buildings. You only start to create incremental value once you exceed this minimum "rent". So, to create value, you want to keep revenue and profits high and operating assets low. In other words, you want high asset productivity. (See blog article on economic profit if this "rent" topic doesn't quite make sense).
Taken together, our first two value drivers tell you to increase profitability and get the most out of your assets. Right now, you should have a warm and fuzzy feeling as your business sense tells you "yes, Richard, that makes sense that I should try to get more profit from my assets." Let's move onto the third value driver, Growth.
Growth: Did you know that Google is valued at 25 times current year profits, while Microsoft is valued at only 12 times? The reason Google is valued much higher is because investors expect Google's profits to grow at a much faster pace. Simply, a growing stream of cash is worth more to investors than if it were constant or shrinking. Profit growth is what's important, but usually we track revenue growth and then ensure that profits follow.
Now that we have laid out the primary value drivers, this article series will take a closer look at each one and identify some specific actions that can drive up company value. Up first: Improve Profit Margin.
