EVA Part 2: Eee Veey Aye

By Matthew Smith

In part one, we had a look at why Economic Value Added (EVA) and EVA Momentum (EVAM) are fantastic ratios to employ when deciding whether to pull the trigger and purchase a particular business.

Enough with the theory let us apply these ratios in practice to help guide you in selecting the best businesses in the Australian equities market.

The starting line up of businesses will be the ASX 100. We will use a tough five gate model to help us determine the greatest businesses.

Zero accounting adjustments have been made as a 10 year period is more than enough to iron out any oddballs.

The Five Gates

Gate 1 - Sustained double digit dividend growth for 10 years
Gate 2 - An average return on capital employed of > 12% over 10 years
Gate 3 - A positive return on incremental capital employed
Gate 4 - A positive EVA average for 10 years
Gate 5 - An average EVAM of > 1% for 10 years

To make the final cut a business needs to pass through each gate, and here are the results of those businesses that made it through all five gates;

These are the best of the best and the greatest businesses in Australia. You can see for the past 10 years Woolworths & Woodside Petroleum have added on average $570 million of value each year for its owners.

We hope all these stocks are on your 'to buy list' as they are certainly on ours!!

Note: We haven’t published the results for Gates 1 through to 3 in this article, however, if you would like this information please let us know. Call (07) 4771 4577.

EVA Part 1: This is not a Woman's name

By Matthew Smith

As a business owner your primary goal in life is to get your managers to increase shareholder value.

To work out if your managers are in fact either creating or destroying value can be a difficult and daunting task.  You are bombarded with many financial ratios from managers and investment analysts which are supposed to aid you in ascertaining how a business will perform.

However, what you may not realise is that many of these so called performance metrics such as; Return on Capital/Equity, Earnings per Share & Profit Margins are not a reliable guide and are very misleading. These ratios do not show you how a company has truly performed, which, in essence comes down to whether or not your highly paid managers have made the correct decisions.

Everyone loves a business with a high return on equity, I don’t know of anyone who doesn’t.

A large business actually paid its managers their bonuses based on the increase in the return on equity. This remuneration policy adopted by the board of directors has caused managers to load up the balance sheet with debt which has increased profits and decreased the equity.

The business in question is in fact a recent fantastic example of the heavy reliance which has been misplaced in the Return on Equity ratio by owners and managers, the business was Lehman Brothers.

The only two ratios that will ensure your highly paid managers are making the correct decisions and are creating shareholder value by not starving the stars and feeding the dogs are Economic Value Added (EVA) & EVA Momentum (EVAM).

EVA is a financial performance measure which calculates the true economic profit of a business. EVA is calculated as net operating profit after income tax minus a charge for the cost of capital employed.

This metric allows you to establish if management's decisions have created shareholder value, merely broken even or destroyed some of your shareholding's value.

EVAM is the next step on from EVA, and is currently the only financial ratio that cannot be fooled with by managers or analysts. EVAM is a percent metric and is calculated as the businesses economic profit (or EVA) divided by its revenue from the prior period.

EVAM in plain English is the size-adjusted change in economic profit and qualifies itself as the missing link in business management as it possesses all of the following qualities;

•    Its based on economics not accounting
•    Its a measure to maximize
•    Size neutral
•    Situation neutral
•    Acts as a early warning system
•    Market calibrated

How come I am writing about this?

I am an investment professional who believes in education and aiding you to be fully informed. I aim to help create greater transparency in the corporate governance arena and I wish to see management's interests become truly aligned with your objective of maximising shareholder value as a business owner.

Grow your investments, give Matthew a call on (07) 4771 4577

Timeless Principles: Seven Cures for a Lean Purse

By Matthew Smith

The gathering of wealth is but one facet of life that many individuals have sought to achieve from the time of antiquity and which still continues today. Individuals seek to accumulate wealth for a variety of reasons; one of which would be considered the most wise and noble is to provide a secure income for your family.

A problem that is prevalent in the vast majority of households in our modern society is that niggling 'want' for a more secure and comfortable lifestyle for our family. This 'want' boils down into a need for ever-lasting financial security.

Most individuals see the best way to solve this problem is by seeking increases in their salary or wages. This misconception, along with another, is that high income earners are definitely wealthy - these are both common fallacies among the vast majority. An increase in household income is fantastic but it will not ultimately solve your problem.

The doctor or lawyer may have a large home and drive a much fancier car than the school teacher or carpenter, but, the same problem arises with higher income earners as it does with lower income earners. The higher income earners generally become higher consumers…it is likely that the more you earn the more you will spend.

The vast majority of households don’t yet understand that the income they earn does not belong to them. It belongs to the grocer, petrol station and butcher and so forth.

To provide a solution to this problem is easier than you may think. To gain financial security you must learn and embrace the rules that govern money. These rules are timeless principles and are adapted from the novel 'The Richest Man in Babylon', which also gave cause for this piece to be written.

Timeless Principles: Seven Cures for a Lean Purse

Cure 1 - Pay yourself no less than 10% of your income
This is where the bulk of your wealth will be created from. Paying yourself no less than 10% of income and saving it for investment will reap untold rewards. By living on 90% of your current income you will not notice a difference in lifestyle. Never stop paying yourself no less than 10% of your income first.

Cure 2 - Control your expenses
By controlling your expenses you are able to identify your needs from wants and take charge of your outgoings.

Cure 3 - Make your investments work for you
Once your investment starts producing income let it multiply by re-investing the income and watch your investments compound over time.

Cure 4 - Consult wise men so you do not lose your savings
You do not seek out the advice of a taxi driver to complete your income tax return; you seek the knowledge and advice of an accountant. You are wise to seek the counsel of individuals who are knowledgeable in handling money.

Cure 5 - Own your own home
By owning your own home you have the cheapest form of housing available. Apart from insurance and taxes, it is far cheaper than renting a home.

Cure 6 - Ensure an income for your retirement and that of your family
You will not be able to work forever. You should focus on working and saving hard to provide a passive income for your retirement. The earlier you start the greater the compounding effect will be.

Cure 7 - Increase your ability to earn
By increasing your knowledge you will be better equipped to make wiser decisions in regards to your investments. Never pass on an opportunity to expand your knowledge. Educate your children on these rules from a young age so that the next generation may out perform the previous.

Those who are wealthy and are financially secure simply know and understand these rules that govern money, and more importantly…obey them.

Want to know more... please give me a call on (07) 4771 4577