Shareholder Value Added (SVA) represents the operating profits that a company generates over and above its funding costs, commonly known as the cost of capital. Fundamentally, it is calculated as Net Operating Profit After Tax (NOPAT) minus the cost of capital.
Key Lessons
- Shareholder value added (SVA) gauges the operating profits surpassing funding costs or cost of capital.
- The SVA method uses NOPAT, avoiding tax benefits resulting from debts, resulting in a financing method-agnostic evaluation.
- SVA calculation poses challenges for privately held companies, given the difficulty in determining the cost of equity.
How Shareholder Value Added (SVA) Functions
For value-driven investors, SVA serves as a tool to gauge a corporation’s profitability and management efficiency, aligning with value-based management principles where maximizing economic value for shareholders stands at the forefront.
Shareholder value is essentially created once company profits outweigh costs. While net profit indicates shareholder value added roughly, it neglects funding costs. SVA distinctly represents the income earned over funding costs.
SVA holds particular advantages, taking into account NOPAT, which is inherently unaffected by financing decisions, providing a fair comparison among companies irrespective of their financing methods. NOPAT also omits extraordinary items, resulting in an accurate representation of the capacity to generate profits through regular operations.
Calculating Shareholder Value Added (SVA)
The SVA formula is straightforward:
SVA = NOPAT - CC
Where:
NOPAT = Net operating profit after tax
CC = Cost of capital
Significance of Shareholder Value Added in Value Investing
During the 1980s, corporate managers faced widespread scrutiny for disregarding shareholder interests, elevating SVA’s prominence. Contemporary investment communities have, however, shifted focus.
Value investors prioritizing SVA tend to seek short-term returns over long-term value, often leading corporations to shy away from capital investments vital for future growth, attracting criticism for potentially promoting shortsighted strategies.
Conversely, investors inclined toward Cash Value Added (CVA) tend to target companies excelling in cash generation. However, this may truncate real long-term value yielded through significant capital investments, a pivotal factor amidst today’s technologically innovative ecosystem boosting concepts like blitz-scaling over short-term financial matrices.
Analyzing the Drawbacks of Shareholder Value Added
One significant drawback of SVA is its complexity in calculating costs of capital, particularly cost of equity, posing considerable challenges for privately held enterprises.
Related Terms: Economic Value, Net Operating Profit After Tax (NOPAT), Cost of Capital, Value Investing, Cash Value Added (CVA).
