What Does Wealth Added Index Mean?
Let me explain what the Wealth Added Index, or WAI, really is. It's a metric created by the consulting firm Stern Value Management, and it's designed to gauge the value a company creates or destroys for its shareholders. According to this approach, you only see true wealth creation if the company's returns—factoring in share price increases and dividends—surpass its cost of equity.
Understanding Wealth Added Index (WAI)
The core idea behind WAI is straightforward: a company's cost of equity needs to be higher than what's available from risk-free investments like government bonds, because investing in a company comes with more risk. As an investor, you demand greater returns for taking on that risk. If the company's returns don't beat its cost of equity, you're better off putting your money somewhere else. In WAI terms, if returns fall short of the cost of equity, the company is destroying shareholder value; if they exceed it, the company is adding wealth for you as a shareholder.
WAI shares similarities with Economic Value Added (EVA), another tool from Stern Value Management, as both compare returns against the cost of capital. But traditional metrics like Return on Equity (ROE) or Return on Assets (ROA) miss this crucial element—they don't account for the cost of capital needed to generate those returns. You might see a company boasting a high ROE, but if the capital cost to achieve it was even higher, that means value was actually destroyed.
Key Differences Between WAI and EVA
There are two main differences that set WAI apart from EVA. First, EVA looks backward, focusing only on past results. WAI, however, factors in both historical share price performance and future expectations. Since a company's equity value is essentially the present value of all its future cash flows, the current stock price already embeds those prospects for value creation—or wealth added.
Second, EVA struggles with cross-border comparisons because it depends on local accounting standards. For example, you can't directly compare the EVA of a U.S. utility company to one in Spain due to differing profit reporting methods. WAI avoids this by relying on share price movements and dividends, which are easy to access and calculate globally.
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