"I think I've been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it," Warren Buffett's business partner, Charlie Munger, once said. "And never a year passes but I get some surprise that pushes my limit a little farther."
For corporate boards, using bad incentives for management pay can be disastrous. (Think Lehman Brothers.) Incentives based on singular metrics such as revenue growth, EBITDA, return on equity, or earnings per share are easily manipulated and gamed. Fortunately, EVA momentum provides a better alternative.
Creator Bennett Stewart of EVA Dimensions, who also co-created EVA (Economic Value Added), calls EVA momentum "the only percent metric where more is always better than less. It always increases when managers do things that make economic sense."
So what does this mean for investors? A positive reading on EVA momentum means a company has created value by increasing its EVA, and a negative EVA momentum means EVA has decreased and less value is being created. EVA momentum is one of the few performance measurements, if not the only one, with such a clear dividing line between good and bad performance.
The best companies, then, create value in excess of their cost of capital, as reflected by positive EVA momentum. The higher the EVA momentum, the faster management is creating value.
Let's look at Office Depot (NYS: ODP) and three of its peers to see how effectively they create value. Here are the trailing four quarters' worth of EVA momentum figures for each company over the past three years, along with rankings by percentile versus the Russell 3000 for the past 12 months' EVA momentum.
2009 Q1 TFQ
2010 Q1 TFQ
2011 Q1 TFQ
Russell 3000 Percentile
OfficeMax (NYS: OMX)
Staples (NAS: SPLS)
Wal-Mart Stores (NYS: WMT)
Source: EVA Dimensions LLC. TFQ = trailing four quarters.
With an EVA momentum of 0.5%, Office Depot's economic value added increased year over year, placing it in the 43rd percentile of all companies in the Russell 3000. All of the three remaining companies had positive EVA momentum over the past 12 months. Remarkably, Wal-Mart has consistently increased its economic value added over the past three years.
Businesses with high EVA momentum are effectively creating value. It will be interesting to see how useful this extremely new metric proves to be for companies and investors. If it lives up to its promise, it will be an essential tool in investors' arsenals.
Another tool for better investing
Most investors don't keep tabs on their companies' fundamental value. That's a mistake. If you take the time to read past the headlines and crack a filing now and then, you're in a much better position to spot potential trouble early. Better yet, you'll improve your odds of finding the underappreciated home-run stocks that provide the market's best returns.
We can help you keep tabs on your companies with My Watchlist, our free, personalized stock-tracking service.
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At the time thisarticle was published FollowDan Dzombakon Twitter at@DanDzombakto check out hismusings and see what articles he finds interesting.The Motley Fool owns shares of Wal-Mart Stores. Motley Fool newsletter services have recommended buying shares of Wal-Mart Stores and Staples and creating a diagonal call position in Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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