March 24, 2020
More on “EVA Metrics and Short-Termism”
– Lynn Jokela
Not long ago, I blogged about EVA metrics and how they may inadvertently reward short-termism. The analysis was qualitative and here’s a memo from Ira Kay and the folks at Pay Governance analyzing EVA metrics from a quantitative perspective. Here, Pay Governance found that EVA may work well for some companies but not all.
The memo’s analysis tested a simple theory: that companies with positive or higher percentage growth in EVA should experience positive or superior levels of TSR. What did they find?
– Of all metrics reviewed, EBITDA growth had the highest correlation with TSR – it was more highly correlated than either EVA growth or EVA momentum
– EVA growth and EVA momentum have similar but not superior correlations to TSR as GAAP metrics such as sales growth, EPS growth and others
– EVA growth and EVA momentum show very low or negative correlation to TSR for companies in certain sectors such as energy and real estate investment trust
The memo says Pay Governance found that it’s possible that EVA metrics may produce a number of “false negatives” – meaning poor EVA results in the ISS test but positive TSR.