Utility of EVA:

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EVA’s most important use is in measuring and rewarding performance inside the firm. It is said, carried out consistently, EVA should help us identify the best investments, that is, the companies that generate more wealth than their rivals. All other things being equal, firms with high EVAs should over time outperform others with lower or negative EVAs. But the actual EVA level matters less than the change in the level. According to research conducted by Stern Stewart, EVA is a critical driver of a company’s stock performance. If EVA is positive but is expected to become less positive, it is not giving a very good signal.

Conversely, if a company suffers negative EVA but is expected to rise into a positive territory, a good buying signal is given. Of course, Stern Stewart is hardly unbiased in its assessment. New research challenges the close relationship between rising EVA and stock price performance. Still, the growing popularity of the concept reflects the importance of EVA’s basic principle: the cost of capital should not be ignored but kept at the forefront of investors minds. Best of all, EVA gives analysts and anyone else the chance to look skeptically at EPS reports and forecasts. From a commercial standpoint, Economic Value Added (EVA) is the most successful performance metric used by companies and their consultants. Although much of its popularity is a result of able marketing and deployment by Stern Stewart, owner of the trademark, the metric is justified by financial theory and consistent with valuation principles, which are important to any investors’ analysis of a company. Because it relies on invested capital, it is more suitable for analyzing asset-intensive firms (those whose value comes largely from tangible assets on the balance sheet) that exhibit somewhat predictable growth trends. The best use of economic profit tends to be in traditional and mature industries. It therefore has less relevance for firms that are valuable largely because of intangible, off-balance-sheet assets; economic profit has shown limited success in high tech and service oriented companies.

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