By: Harry M. Jansen Kraemer Jr.
best self, best team, best partner, best investment, and best citizen will improve financial performance
By strict definition, shareholder value is generated when an investment made today is worth more in the future. I do not purchase a particular stock because I like the name or because I think it makes cool products. If, as an investor, I buy a stock for $30 a share today, the only economic reason is because I believe it will appreciate in value: from $30 to $35, $38, $40 and so on.
Shareholder value is composed of two parts: how much the stock has increased in price (otherwise known as stock appreciation), and the amount of dividends paid to shareholders over a period of time. To express it as a formula, stock appreciation plus accumulated dividends equals total shareholder return.
It doesn’t matter if the CEO says something fascinating at the annual meeting, or the chief marketing officer unveils a slick campaign for a new product, or the company publishes a beautiful annual report with charming pictures of children dancing in the sunlight—show me the money!
That’s why when I want to analyze how well a company is performing financially, I always turn to a chart in the annual report to answer a few key questions:
- How much is my investment worth today versus when I purchased the stock? What is my total shareholder return over a specific period (one year, three years, etc.)?
- How does my total shareholder return compare to benchmarks, both in the overall market and a peer group of similar investments? If a stock I purchased increased from $30 a share to $36, generating a 20 percent return, am I satisfied? What if during that period the total market increased 25 percent or a peer group produced a 50 percent return?
These same benchmarks — total return versus the market as a whole and total return versus a peer group — are also the measures by which professional investment managers gauge their own results. In financial terms, managers seek to generate
alpha, meaning the amount of return that is over and above what is created by or attributable to the overall market. The more alpha that is generated on a risk-adjusted basis, the better job an investment manager is doing in selecting investments and managing a portfolio. While it is important to understand the company’s sales and marketing programs, its investments in research & development, its planned investments in capital equipment, and its global strategy, these factors alone do not necessarily mean that shareholder value is being created. Rather, the sum of these efforts, if successfully executed, will be reflected in total shareholder return.
I hold values-based leadership to the same rigorous measure. If we really believe that the five bests (best self, best team, best partner, best investment, and best citizen) will improve financial performance, then the proof is in the total shareholder return they generate. Otherwise, the bests are only interesting concepts or nice things to do, but they cannot stand up to the measures that determine investment performance or create financial stability for an organization. It’s like going to the doctor for your annual physical. You may be happy to report that you’re walking more, eating green leafy vegetables, and drinking plenty of water, but if you’re 25 pounds overweight, your cholesterol is 30 points higher, and your blood pressure is soaring, then what you’re doing is not very effective!
The five bests, if done well, generate the kind of improvements that are critical to a successful organization. If not, then something is missing. Returning to our annual physical analogy, perhaps your healthy habits are being undermined by unhealthy ones, such as overindulging in the wrong foods. If we think we’re doing our best in all areas, but the organization is not generating a shareholder return that is at least in line with its benchmark group, then we have to go back and reexamine our execution around each best.
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About the Author:
Harry M. Jansen Kraemer Jr. is a professor of management and strategy at Northwestern University’s Kellogg School of Management. He is the former chairman and chief executive officer of Baxter International Inc., a multibillion-dollar global health care company, and the author of From Values to Action.
For more information, please visit www.harrykraemer.org.
Credit for the excerpt:
Becoming the Best: Build a World-Class Organization Through Values-Based Leadership.
Copyright © 2015 by Harry M. Kraemer. Reprinted with permission of Wiley.
By Harry M. Kraemer
Published by: Jossey-Bass (An imprint of Wiley)
February 2015; 224 pages; Hardcover