porcupine, re: EVA, IBM, ROE: Great post!
Thanks so much for this post, it pulled together a lot of "GAAP fixups" for me. In particular, how and why goodwill and R&D ought to be realistically treated.
I haven't recently gone over your EVA stuff, but I did have one question about it that has bugged me since I read your analysis of Novell. That is, your input of "x% return on equity capital". I understand that one ought to assign a fair return to the cost of equity capital, however after an EVA analysis is done, one arrives at an excess/deficiency of return.
Why not initially assign a "cost of equity capital" of 0%, then run the numbers, and then have a residual profit or loss, which would belong to the company's shareholder equity. Then, one would have to consider whether that return on equity capital indicated that the company was or was not well run. Surely a sound, predictable low-risk company could legitimately provide lower returns on equity capital, and still be considered to be a sound, "value adding" company. Whereas a riskier company ought to earn a higher return in order to justify its worth. I guess what I am saying is that ultimately one ought to apply a risk-based weighting to the cost of equity capital, and that I think this should not be done up front, but rather the raw number obtained at the end of the process should then be considered against the analyst's best analysis of risk, and only then should a decision be made as to whether or not management is producing net value for shareholders' capital.
Once again, thanks for an A-1 article. Keep up the great work!
- Daniel |
