At Kings Point Capital Management, EVA is one of the quantitative techniques used when assessing equity investments. We feel that adding this metric to our analytical process has helped us identify companies that are able to generate more wealth than their competitors and therefore make better investments for our clients.
Developed by Stern Stewart & Company, EVA is the net operating profit after tax (NOPAT) minus a charge for the weighted average cost of capital. EVA is a measurement of the creation of shareholder value by company operations. As opposed to EVA, typical investment analysis focuses on earnings per share which does not take into account the full opportunity cost of capital employed. It is possible for a company to have positive earnings yet actually be destroying value, because its’ real earnings are less than the resources it uses to produce them.
Standard profit according to GAAP must be adjusted before it can be used to calculate EVA. These adjustments in the areas of inventory, depreciation, research and development, and others generate a real net operating profit after tax. The level of EVA is less important than the change in EVA over time and in relation to the company’s competition.
The addition of EVA analysis to our investment selection procedure helps to insure that we look critically at company reports and forecasts of its value creation capabilities.