Shareholder value added (SVA) simply means that a management team is concentrating on increasing their shareholders’ net value in the stock.
The whole reasoning behind a person investing in stock, is that they believe that it will return the investment, plus a healthy rate of return to the investor.
Management teams, and, for that matter, employees of any company, should perform at 100% in order to maximize the returns for their shareholders.
In theory, the management team is hired and put in place by the shareholders with the expectation that they will realize maximum returns for the shareholders.
This is the heart of any investment and exactly what management teams are supposed to concentrate on, according to corporate finance theory.
How shareholder value is created
Creating shareholder value is actually a four-stage process that involves setting goals for the company and measuring the success of how those goals are obtained.
Basically, every business sets out at least one or several goals relating to what it wishes to achieve.
This is ultimately the company’s ethos, what the business stands for and why it was created in the first place.
The next stage of the process is to set out ways to measure the success of the management team achieving these goals.
The third stage would be in operations looking to achieve maximum returns as the business achieves its preset goals.
Finally, the corporation will need to watch and measure its returns over a set period of time in determining how well the company has met its goals.
Thus, shareholder value is created through this four-stage process as it moves from concept to operations, and to measurement and success.
SVA is normally calculated by subtracting the company’s total cost of capital from its net operating profit after taxes (NOPAT).
Shareholder Value Added (SVA) = NOPAT – Cost of Capital
To help you understand clearly how to calculate the SVA, let’s take a look at the following example:
You are considering investing in company A which has a net operating profit of $15 million. Applicable tax rate for the company is 35%. The company’s capital amounts to $6 million.
In order to accurately calculate the SVA of this company, you simply use the SVA formula given above, and the final calculation is as follows:
Shareholder Value Added (SVA) = $15 x (1 – 35%) - $6 = $3.75 million
In this example, the company A’s SVA is $3.75 million.
Shareholder value analysis can be helpful to a management team by keeping its focus on areas in the business, which can lead to greater appreciation in value for shareholders.
Thus, a management team can develop strategies, which will promote growth in key areas of the business, such as sales growth rates, tax rates, operating margins, and setting goal returns.
All of these areas can assist management in keeping its business operations focused on investor’s returns.
There are downsides of course in this analysis.
This is because they may focus on only certain key drivers and ignore other parts of the business, which may lead to shareholder value as well.
For example, decreasing R&D might have an immediate effect on decreasing expenses and increasing operating margins.
For the long-term survival of the company, this could be extremely harmful.
Also, some of this information may not be readily available, even in the corporation’s internal communications, thus causing the management team to lack a complete understanding of the overall business.