Deciding where to invest capital is among the most critical executive responsibilities and is the defining difference between an executive and a manager. For better or worse, the capital deployment and allocation decisions during an executive’s tenure have a direct and lasting impact on a company and shareholder value. Given this magnitude of significance, it is surprising that there is such a widespread misunderstanding of how capital deployment choices affect long term value in the capital markets.
Many companies consider each capital deployment alternative in a vacuum – for example, considering share repurchases in isolation from discussions about investing in additional growth. Complicating this is the use of different measures and analytical approaches to assess the value impact of each decision. Often, capital structure and share repurchase decisions hinge on EPS accretion/dilution or the impact on the company’s weighted-average cost of capital. Organic investments are decided upon using IRR, payback or growth in sales and profits, while acquisitions are considered on net present value analysis, EPS accretion/dilution or more comprehensive ROIC impact. This basket of different analytical techniques is confusing for managers that lack formal financial training, it presents an obstacle to comparing alternative uses of cash and it breaks down accountability.
We work with clients to bring the analysis of these decisions under a consistent framework.
We help our clients answer these common questions:
- What is the value of the company’s long-range strategic plan? Does it meet, exceed or fall short of the external market’s expectations?
- Which businesses contribute the most to the overall value of the company? Where should additional resources be devoted? What is the right balance of growth and return at each business?
- What acquisition opportunities exist? How should the contribution to the overall company be evaluated?
- What is the best use of excess financial resources? Given the difference between management’s plan and the current share price, are the company’s shares a good investment? Are there better uses of capital including further reductions in debt?
Beyond the numbers however, we work with clients by looking at the market’s reactions to actual capital deployment strategies. Often, the message from the market and how shares are actually priced conflict. This is most often true for share repurchase – investors constantly ask management teams to repurchase more shares but then reward the companies who find growth opportunities. We provide fact based analysis to help a management team respond to these conflicting signals.
Our approach supports the company-specific analytics with observations in the market of what investors actually do. This provides our clients with the evidence and support necessary to defend their capital allocation strategy
with clear and understandable evidence. The following table from “Are Buybacks the Best We Can Do?” indicates how valuable investing in the business can be versus buying back stock.
We conduct extensive analysis of this nature for our clients using companies in their own industry to improve relevance.