EVA: The Real Key to Creating Wealth
Al Ehrbar says there's a more meaningful way to gauge a company's performance than by quarterly earnings or other traditional yardsticks. It's called EVA, or economic value added, and it's helped turn companies like Coca-Cola into great engines of profit for shareholders. InEVA: The Real Key to Creating Wealth,Ehrbar describes how the formula works and how it can determine how efficient your company really is.Unlike other financial ratios like EPS, or earnings per share, and ROE, or return on equity, EVA takes into account a critical factor: the cost of capital, or how much it costs to produce $1 in profit. Other measurements can be misleading because they show profits without deducting the price of producing them--a company that spends $1 to earn $1 could still appear profitable. As a result, Ehrbar says, those ratios can often show "accounting profits" rather than true profits as does EVA.Ehrbar, a former editor and writer at such publications asFortuneand theWall Street Journal, builds a convincing case for EVA. Take Wal-Mart vs. Kmart in the 1980s, Ehrbar writes. By traditional accounting measures, Kmart appeared to be the more profitable company, with an average gross profit margin of about 29 percent, while Wal-Mart's was only about 23 percent. But over the decade, Kmart's market value plummeted and Wal-Mart's surged. "So why was Wal-Mart a winner and Kmart a loser?  Because Wal-Mart was using its capital more efficiently," Ehrbar writes, with higher sales per square foot of space and lower inventory as percentage of sales than Kmart.  WhileEVAis geared for corporate managers, investors also will find a comprehensive method for judging a company's value.--Dan Ring