The accompanying table illustrates the relationship between wealth creation as measured by Market Value Added (MVA) and spread between the return on invested capital (ROIC) and the cost of Capital (WACC). Company like Costco is creating enormous MVA with lesser capital than Pfizer Inc. Best Buy also has MVA that is almost double its capital.
Of the four selected companies, General Electric (GE) has generated the highest MVA – amounting to over $377 billion- both in terms of value and of proportion in relation to its capital. GE’s MVA is based on its profitability and the investing public’s good perception of the company, which has made the company’s stock one of those with the highest turnover in the daily trading and has enabled it to steadily increase in price year-on-year.
$ Million Wealth Creators MVA Capital ROIC WACC Spread Pfizer Inc. (CAPM) 33,577 70,041 11.80 9.37 2.43 Pfizer Inc. (DCF) 11,304 70,041 11.80 10.75 1.05 Costco (CAPM) 37,478 9,488 11.84 11.25 0.59
Best Buy (CAPM) 12,824 6,841 23.60 11.00 12.60
General Electric 376,751 115,559 28.34 4.26 24.08
In terms of invested Capital, GE has the highest of the four, being the company that is most diversified in terms of business lines and industries and the biggest in terms of asset base and number of employees. The size of capital – a total of over $113 billion - is also determined by the products and services provided by the companies. Of the four, GE
requires the highest amount of capital infusion for the acquisition of high-technology equipment and plants to manufacture the wide-ranging specialized products of the company. GE has also evolved into a conglomerate engaged in finance, infrastructure, insurance and healthcare. Through the years, the GE brand has become globally accepted as a leading brand that promises quality and efficient service with each product the company offers. Thus, GE has become an icon – investors have put their money in the company to give it sufficient capital base for its operations and the GE management has run the company effectively through the years. Goodwill is well put in place; the company’s MVA and capital figures say so.
The same goodwill has resulted to the relatively low WACC of GE, which is computed at 4.26. GE can generate capital at low costs because it has recourse to cheaper sources of capital, such as selling company stocks and issuing bonds. In contrast, Costco has relatively high WACC (11.25%), and this has eaten up the company’s ROIC (11.84). This reflects Costco’s lack of access to cheaper cost of capital. Thus, Costco had to avail of loans at higher rates to fuel its operations. Though Costco has generated value for its investors by making the market value of the company’s shares worth so much more than the actual investments therein, Costco has to work on finding cheaper capital so more of its income can be enjoyed as dividends or can be appropriated for the company’s expansion. As it is now, the bulk of Costco’s income goes to payment of bank interests and other costs pertaining to the company’s acquired capital resources.
Best Buy Co. did a good job of maximizing shareholders wealth with a very large number of over $12 million as MVA from out of its $6.80 capital. The company’s operations
have done well, as reflected by the ROIC figure of 23.60. Unlike Costco, it is good to see that Best Buy Co.’s WACC is much less than its ROIC, thus leaving more as spread.
Pfizer has been operating profitably, with its ROIC at 11.80. The company has access to capital with a WACC of 9.37. The company, thus, has a net spread of 2.43, but its MVA of $33.6 billion is way below its total capital of $70.0 billion. This indicates that Pfizer is not favorably rated in the investors’ world; its company stocks do not enjoy being traded at rising prices.
Among the four selected companies, therefore, Costco is creating the most wealth in terms of MVA, and then GE, in terms of spread.