Who’s Really Winning?
Cultural commentators have recently described the millennial generation as the “Everyone gets a medal generation.”
The criticism leveled is that by providing this generation with undifferentiated praise, they are not being prepared for the real world, where in fact there are winners and losers.
Lately, there seem to be a lot of millennial corporate rankings where all companies are hailed regardless of performance. This approach fails to distinguish those CEOs who have successfully developed and executed upon innovative and differentiated strategies.
We decided to take a different approach and evaluate “Who’s Really Winning” among 100 CEOs of Southern California’s largest public companies.
Given that a CEO’s primary duty is to build an organization that delivers sustainable improvements in long-term value, the yardstick chosen for evaluating CEO performance is economic profit. We chose economic profit because it is a measure of true value creation that takes into consideration the profits a company makes over and above the level of investors’ required returns on the capital invested by the company.
In 2011, which was a year of strong profitability for many companies, 58 out of the 100 CEOs included achieved a positive economic profit. Conversely, 42 companies, or more than 40%, delivered negative economic profits by earning returns below their cost of capital.
The charts below highlight the Top and Bottom 5 companies in the SCCO International CEO Performance 100 based on 2011 Economic Profit:
Who Are the Return Champs?
Southern California’s corporate landscape is dominated by mid-size companies. Excluding the largest ten companies in our ranking, average annual sales in 2011 was $1.2 billion. To recognize performance over this broad company universe, we have chosen to also rank CEOs according to their value spread, the difference between their company’s return on capital and their cost of capital.
Although growing economic profit (which combines efficiency and size in one number) should be the
long-term maximizing objective, looking at value spread allows us to standardize for size and compare all CEOs in terms of how well they have employed investors’ capital. Companies with a positive value spread are earning returns above their cost of capital and creating value for investors, while companies with a negative value spread are earning returns below their cost of capital and decreasing value for their investors. If a company has a negative value spread, it will generate relatively more value by focusing first on improving margins and capital efficiency to improve its value spread before focusing on growth. High growth with a negative value spread will only drive down economic profit, cash flow, and value.
long-term maximizing objective, looking at value spread allows us to standardize for size and compare all CEOs in terms of how well they have employed investors’ capital. Companies with a positive value spread are earning returns above their cost of capital and creating value for investors, while companies with a negative value spread are earning returns below their cost of capital and decreasing value for their investors. If a company has a negative value spread, it will generate relatively more value by focusing first on improving margins and capital efficiency to improve its value spread before focusing on growth. High growth with a negative value spread will only drive down economic profit, cash flow, and value.
The charts below highlight the Top and Bottom 5 Companies in the SCCO International CEO Performance 100 based on 2011 Value Spread:
By focusing on economic profit and its components in our ranking, we have differentiated those companies in 2011 that are truly creating value from those that are not. While this ranking focuses on one year of performance, the market rewards companies that consistently improve economic profit year over year with increases in share price.
The 2011 winners have been determined by strong leadership, effective strategy, disciplined execution and a commitment to building an organization focused on long-term value. Future winners will follow the same path.
SCCO International is a global management consulting firm with a focus on the simple yet far-reaching concept of consistent value management. We have been working with our clients for over 15 years to assess their business portfolios and develop and implement strategies that achieve sustainable competitive advantages and drive returns for their shareholders.
More information about SCCO International is available at http://scco.com.
