Corporate Finance and Risk

The Core of Value

A business’s value is driven by its growth and return on capital, and resulting cash flows. Many evidences have proved that value always increases with the rise of ROIC. That means if other conditions are the same, the higher ROIC the better. But it is not the same case for growth. When ROIC is high, high growth can boost the increase of value. However, when ROIC is low, high growth will cause decrease of value. Therefore, it is really significant for managers to understand the relationship between ROIC, growth and value.

The Conservation of Value

Value is created when companies generate higher cash flows, not by simply rearranging investors’ claims on cash flows. If a company just change the ownership of cash flows without changing the total amount of available cash flow (like issue bonds to buy back stocks), then value keep constant. Although this principle seems obvious, some high level managers and investors still cannot resist the temptation of free lunch and try to acquire more value by using some accounting tricks.

The Expectations Treadmill

Movements in company share prices reflect changes in the stock market’s expectations, not just underlying performance. If the performance of a company achieves the expectation, then the price of its stock will rise. But meanwhile, the speed of the “treadmill” will be boosted. And in order to maintain the higher stock price, the company has to improve its performance continuously. As a result, those companies with a relatively weaker start are more easily to win in stock market, because it is easier for them to reach the standards.

The Better Owner

The value of a business is not an absolute but, rather, depends on who is managing it and the strategy pursued. This is because different owners can produce different cash flows based