The EVA Momentum Ratio
No doubt that financial ratio's have become a main-stay for all of us for evaluating the financial performance of companies. However all of these ratios such as Return on Assets or Asset Turnover are rooted in the world of traditional accounting and financial statements. And accounting and financial statements are poor indicators of true long term value. For example, most financial indicators fail to consider how well a company effectively manages its capital. To counter this short coming larger companies have embraced alternatives such as Economic Value Added or EVA. Creating EVA is not unlike you how you go about creating positive Net Present Values. You have to invest your capital in such a way that you increase economic income or value for the company. If NPV is zero, then EVA is essentially zero.
To help bridge the gap between ratios and EVA, a new ratio has been introduced called the EVA Momentum Ratio. It requires that you calculate EVA and simply relate your change in EVA against your past base year sales. For example, if last year you had EVA of $ 3 million and this year you calculated $ 4 million in EVA, then you increased EVA by $ 1 million. If last year sales were $ 50 million, that gives us an EVA Momentum Ratio of 2% ($ 1 million divided by $ 50 million).
“Many performance ratios lie about a company's health. A new metric has emerged that can't easily be gamed – and savvy investors and managers will check it out.” – Geoff Colvin on Business, Fortune Magazine, January 18, 2010
The EVA Momentum Ratio is easy to read since it represents a simple index of value. If the ratio is positive, you are creating some measure of value. If the ratio is negative, then you are not creating value and when the ratio is zero you are breaking even. Only a few companies seem to create a positive ratio of 2% to 4%. The reason lies in the long term challenges of creating value. It requires that management pay attention to something other than just revenues and profits. The EVA Momentum Ratio corrects for this traditional myopic short term view of financial performance.
One final point that makes the EVA Momentum Ratio appealing is that it is not easily manipulated since it uses the change in EVA as its numerator and rules surrounding EVA tend to remove many of the distortions that are embedded in financial statements such as expensing long-term research projects. You can learn more about the EVA Momentum Ratio at the official web site: www.evadimensions.com
Written by: Matt H. Evans, CPA, CMA, CFM | Email: firstname.lastname@example.org | Phone: 1-877-807-8756