theoretical relationship between market value, roic, and growth wacc = 8% *assumes a competitive...
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THEORETICAL RELATIONSHIP BETWEEN MARKET VALUE, ROIC, AND GROWTH
WACC = 8%
*Assumes a competitive advantage period of 10 years, after which ROIC = WACC is assumed
0
1
2
3
4
5
6
7
8
9
10
0 5 10 15 20 25
Market value/capital ratio*
Revenue growthPercent
ROICPercent
15
12
9
6
EMPIRICAL RELATIONSHIP BETWEEN MARKET VALUE, ROIC, AND GROWTH
Sample of 563 North American companies
*Defined as market value of operations divided by invested capital including goodwill
**ROIC based on invested capital including goodwill
Revenue growth 1993-2003 CAGRPercent
0
1
2
3
4
5
6
7
8
0-5 5-10 10-15 15-20 20-25
<15
12-15
9-12
6-9
0-6
Market value/capital ratio, 2003* ROICPercent
P-value2
Percent
REGRESSIONS OF MARKET-VALUE-TO-CAPITAL WITH ROIC AND GROWTH
*Defined as market value of operations divided by invested capital including goodwill**P-value represents the probability that the tested relationship does not hold, with a P-value of 5% used as the threshold of statistical significance
0-66-99-1212-15>15
MV/IC*MV/IC*MV/IC*MV/IC*MV/IC*
93146124
61139
GrowthGrowthGrowthGrowthGrowth
0.250.763.222.147.99
0.520.822.831.433.18
6041
116
0
ROIC cohortPercent
Dependentvariable
Number ofobservations
R2
PercentNumber ofobservations
Dependentvariable
46 19.3 21.5 0563MVI/C*Full sample
Variable1 Slope1 t-Stat1
P-value1**
Percent
ROIC
Variable2 Slope2 t-Stat2
Growth 2.0 3.4 0
P-value1**
PercentVariable1 Slope1 t-Stat1
VALUE OF COMMODITY CHEMICAL COMPANIES DRIVEN BY ROIC AND GROWTH
*June 2002 (based on Invested Capital 2001)
Source: T. Augat, E. Bartels, and F. Budde, “Multiple Choice for the Chemicals Industry,” McKinsey on Finance, Number 8 (Summer 2003), pp. 1-7
Market value/Capital ratio, 2002*
Below average Above average
ROIC
Sales growth
1.5 1.6
1.3 0.5Below average
Above average
DCF VALUATION CLOSE TO ACTUAL MARKET VALUE
Source: Annual reports; IBES; Bloomberg; McKinsey analysis
DCF results relative to market value of equityIndex
Electric utilities
Pharmaceuticals
Consumer goods
Oil majors
105 108 10798 94
74
107 10392
76
108123
103 98 95
9788
98 99
126
ELE EN RWEA SSEZY UN NSRGY PG KFT LORLY
PFE GSK JNJ NVS MRK XOM BP RD/SC CVX TOT
EON
CHANGE IN EXPECTATIONS IS KEY DRIVER OF TOTAL RETURN TO SHAREHOLDERS
*Expectations measure is based on change in analyst consensus EPS forecast for running fiscal year (FY 0), the following fiscal year (FY 1) and change in analyst consensus 5-year growth expectation (LTG)
**Scaled based on actual revenues
***P-value represents the probability that the tested relationship does not hold, with p-value of 5% used as the threshold of statistical significance
Source:Datastream; Compustat; IBES; Bloomberg; McKinsey analysis
S&P 500 companies, 1993-2003
Coefficient
Expectationsmeasure*
Change incash flow
Actualcash flow**
Change ineconomic profit
Actualeconomic profit**
Adjusted R2
PercentP-value***Percent
18.0
8.0
0
1.5
2.0
0
0
0
0
0.32
0.15
0.08
0.49
t-Statistic
LTG 01.91 8.6
13.5
3.0
5.1
6.9
00.33 10.5FY 100.15 4.7FY 0
LONG-TERM PERFORMANCE EXPECTATIONS DRIVE SHARE PRICE
Source: Datastream; IBES; McKinsey analysis
Abnormal return on 137 announcements of fiscalyear earnings for 2002 by U.S. companiespercent
Lower Higher
Change in expectedEPS for 2004 –“change in long termexpectations”
Actual EPS 2002 relative to expected EPS for 2002 –“short-term surprise”
2.3 3.6
(4.1) 1.0Negative
Positive
MARKET REACTION TO PHARMACEUTICAL PRODUCT ANNOUNCEMENTS
Source: Datastream; Factiva; McKinsey analysis
Abnormal returns percent, 1998-2003
Lilly-Zovant
AstraZeneca-Nexium
Lilly-Evista
Wyeth-Enbrel
Wyeth-Protonix
Abbott-Humira
Pfizer-Zeldox
NovoNordisk-Ragaglitazar
Schering-Angeliq
NovoNordisk-Levormeloxifene
BMS-Vanlev 2
AstraZeneca-Iressa
BMS-Vanlev 1
Developmentsuccesses(e.g., approvals)
Developmentsetbacks(e.g., withdrawals)
Announcement return -1/+1 day
Announcement return -3/+3 days
(6.4)
(12.3)
(12.6)
(15.5)
(16.4)
(19.2)
(25.5)
7.9
8.6
11.1
11.8
12.0
14.8
(1.4)
(13.7)
(10.0)
(7.7)
(18.4)
(20.3)
(24.9)
5.0
4.6
2.3
10.8
8.3
14.1
NO CLEAR IMPACT OF U.S. GAAP RECONCILIATIONS
Source: SEC filings; Datastream; Bloomberg; McKinsey analysis
Average cumulative abnormal return (CAR) index
Positive earningsimpact (n = 16)
Negative earningsimpact (n = 34)
• CAR• t-Stat
(0.5%)(1.54)
1.7%14.63
• CAR• t-Stat
-1/+1
Day relative to announcement
-30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30
110
108
106
104
102
100
98
96
94
9290
NO CONSISTENT MARKET REACTION TO SFAS-142 GOODWILL ANNOUNCEMENT
Source: Datastream; McKinsey analysis
Abnormal return on announcement datePercent
Summary statistics
• n = 54• R2 = 0.0%• Slope = (0.01)• t-Stat = (0.15)• P-value = 88.5%
Goodwill amortization as percent ofyear end equity market value, 2001
10 20 30 40 500
Average
Time Warner
CARt-Stat
0.1%0.3
-1/+1
Day relative to announcement
MARKET REACTION AT ANNOUNCEMENT OF GOODWILL IMPAIRMENT
Source: SEC filings; Datastream; Bloomberg; McKinsey analysis
Cumulative abnormal return (CAR) index, n = 54
105
100
95
90
85
75
70
65
110
80
Impact of option expense on pre-tax incomePercent*
VOLUNTARY OPTION EXPENSING HAS NO IMPACT ON SHARE PRICE
*Defined as the absolute value of option expense divided by the pre-tax earnings before option expense
Source: SEC Filings; Datastream; Bloomberg; McKinsey analysis
Abnormal return on announcement datePercent
Abnormal return
Summary statistics
•n = 120•R2 = 0.4%•Slope = 0.01•t-Stat = 0.7•P-value = 47.1%
0 10 20 30 40
EFFECT OF INVENTORY ACCOUNTING CHANGE ON SHARE VALUE
Source: S. Sunder, “Relationship Between Accounting Changes and Stock Prices: Problems of Measurement and Some Empirical Evidence,” Empirical Research in Accounting: Selected Studies, 1973
Cumulative abnormal returnPercent
110 firms switching to LIFO 22 firms switching from LIFO
0.125
0.075
-0.025
-0.075
-0.125
-12 -7 -2 3 8 13
0.125
0.075
0.025
-0.025
-0.075
-0.125
-12 -7 -2 3 8 13
0.025
ESTIMATING FUNDAMENTAL MARKET VALUATION LEVELS
*12-month forward-looking price-to-earnings ratioSource: IBES; McKinsey
Actual P/E*
Predicted P/E*