The Cash Trap

Cash may be a comfort in an uncertain economy, but it can also be a drag on shareholder value.

“Because we’ve been delivering strong results, we haven’t had a whole lot of pressure to pop margins up for short-term benefit,” says Cognizant CFO Gordon Coburn, who is also the company’s chief operating officer and treasurer. “We tell our investors we’re in this for the long term, and the vast majority of our institutional base understands that our strategy is paying off.”

Success Factors

BCG readily concedes that finding the right balance between delivering results over the short term while retaining the financial flexibility to invest for the long haul is a tricky undertaking — one that will require different approaches from different companies in different industries. But it also offers clues as to which factors managers should focus on.

Those factors aren’t always intuitive. For example, many executives tend to focus on revenue growth — growth that generates returns above the company’s cost of capital — as a major driver of shareholder returns. Indeed, over the long term it is the key driver. But when it comes to near-term returns, growth’s contribution to shareholder returns is secondary to improvements in the company’s valuation multiple — market value divided by earnings before interest, taxes, depreciation, and amortization.

A relatively small number of factors explain as much as 80 to 90 percent of the differences in valuation multiples among peers, BCG says. Those factors tend to cluster into four broad categories: revenue growth, profitability, risk, and “fade” (BCG’s term for the confidence investors have that current levels of growth or profitability can be sustained). Which factor plays the greater role in determining a company’s valuation multiple depends on its business. Revenue growth can be a key differentiator in high-growth industries such as software, for example, but a secondary factor in, say, pharmaceuticals, where the research-and-development spend relative to revenue is a better indicator of long-term prospects.

On the other hand, BCG argues that a number of broad trends are today affecting valuation multiples across many industries. Most strikingly, it says concerns that companies will poorly deploy accumulated cash have made investors sensitive to any signs of either fade in a company’s current profitability or increased risk relating to its growth strategy.

To invest for long-term growth without alienating investors, BCG says companies should reexamine how their investments align with investor expectations. Growth companies might weed out businesses that operate with a value proposition; value companies might temper risky growth plans and pay more attention to increasing the dividend. At the same time, BCG urges companies to look for new opportunities for growth, whether through innovation or by leveraging what it calls “megatrends,” such as the rise of China as a major industrial power or the increasing scarcity of energy resources. MEMC Electronic Materials Inc., a $1.5 billion maker of silicon wafers that shared the top spot in BCG’s ranking with an annualized TSR of 62 percent, has done that by beginning to sell its wafers not just to the computer industry but also to the solar-energy industry, where they are used in solar panels.


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