By : Hendra S Raharjaputra

Executive Director – HSFAMES GLOBALMINDS
 

       Unfortunately , most tradition ways of understanding TRS are flawed. Many of them, executives, board members, the press, and investors regularly look at total returns to shareholders ( TRS ) as an important metric of value creation. TRS, like any performance metric , is instructive only  when users understand about  the components . Many of them , for example , define TRS as the sum of the percentage change in Earning + Price Earning Ratio ( P/E ) + Dividend . This simplistically connects TRS with changes in earnings , as if all forms of earning growth created value equally. Not so. Earnings growth create more value when it is rooted in activities that generate high returns on invested capital ( ROIC ) – such as the discovery of new customers segments for a company’s products – than in activities with low return on capital, such as many acquisitions when the goodwill paid is taken into account.

       When they relate TRS to dividend payment , this traditional approaches also err. For example , If a company pays dividend today by taking on more debt , that simply means that future dividends must be lower. If a company pays a higher dividend by forgoing attractive investment opportunities, that also reduces future dividends. Finally , the usual approaches fail to account for the impact of financial leverage. More clear example, take a closer look at the two companies in the same industry.

 

Zero growth return                                  7,7                                 4,7

 

   Revenue growth                                  8,4                                23,7    

 Required investment                         - 7,5                             - 27,6

 

Net revenue growth                                0,8                              - 3,9

Change in ROIC                                   - 4,9                               34,6

Change in P/E multiple                         5,3                             - 14,4

Capital structure impact                       1,3                                1,1

                                                                                            Sources : Fortune 500 and McKinsey Quarterly

-          In 2003, Interbrew ( now InBev ) was facing a bigger challenge to generate strong TRS . InBev’s zero-growth return three percentage points below that of Heineken.

-          Over the subsequent five years , revenue growth was not an important factor for shareholder return : InBev’s top annual growth of almost 24 % did not create positive shareholder return once capital expenditure and goodwill paid were taken into consideration.

-          InBev’s outperformance of Heineken in term of TRS was driven by its superior improvement in return on capital over the period ( 34,6 % ). InBev improved its Return On Invested Capital ( ROIC ) from 14 % in 2002 to an industry leading 47 % in 2007 . Heineken, by contrast , saw its ROIC decline over the same period to 17 % , from 24 % , thereby losing around 5 % in TRS.

-          Finally, InBev’s TRS was negatively impacted by 14,4 % as it valuation multiple decline from 2002 to 2007 , reflecting lower stock market expectations that InBev would further improve its value creation. By contrast , the market increased its expectation for Heineken to improve its performance and growth after 2007, driving up TRS by 5, 3 %

-          The analysis shows that InBev generated its shareholder returns through very strong operating improvement, not top line growth. In contrast, most of Heineken’s TRS was due to a high zero growth return and increased investor expectation.

 

-          Zero growth return : equals the earning yield – that is, the inverse of the earning multiple.

-          Required investment : ( invested capital year-n minus year- base ) / equity value