Shareholder Value Analysis

Most corporations report that their number one goal is to maximize shareholder value. Unfortunately, there is often a big disconnect between this lofty goal and the reality of how corporate business units are managed.

The shareholder value approach is different from the return on equity (ROE) approach or the return on income (ROI) approach. It is also different from the goal to be the market share leader at any cost. Although it often helps to be the market share leader, especially when strong economies of scale are present, the ultimate goal of the shareholder value approach is not market share, but rather, to maximize discounted cash flow.

For a typical business unit, maximizing cash flow can be estimated by adding:

• the discounted value of projected cash flows (inflows and outflows) for the next ten years,
• the discounted value of the projected sale price of the business at the end of the tenth year.

For a typical corporation, the shareholder value of each SBU should be added together and then added to

• the discounted value of the projected cash flows from corporate investments.

It is important to recognize that a change in strategy implies a change in projected cash flows and, therefore, a change in shareholder value.

For an excellent discussion on the shareholder value approach, read Alfred Rappaport's, Creating Shareholder Value, 1986, The Free Press.

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Copyright 2008 Alan S. Michaels               Alan S. Michaels    All Rights Reserved.
Last modified:   Tuesday February 19, 2008