What Is Shareholder Value Added (SVA)?

What Is Shareholder Value Added (SVA)?

Let me explain Shareholder Value Added, or SVA, directly to you. It's a straightforward measure of the operating profits a company generates beyond its funding costs, which we call the cost of capital. You calculate it basically as net operating profit after tax, known as NOPAT, minus that cost of capital, derived from the company's weighted average cost of capital.

Key Takeaways on SVA

Here's what you need to know about SVA. It directly measures the operating profits a company produces in excess of its cost of capital. The formula relies on NOPAT, which comes from operating profits and deliberately excludes tax savings from debt usage. One major downside you should consider is that SVA is tough to compute for privately held companies.

How Shareholder Value Added (SVA) Works

Some value investors turn to SVA to evaluate a corporation's profitability and how effectively management is performing. This approach aligns with value-based management, where I believe the primary goal of any corporation should be maximizing economic value for its shareholders.

You create shareholder value when a company's profits surpass its costs, but there are various ways to figure this out. Net profit gives a rough idea of added value, yet it ignores funding costs or the cost of capital. That's where SVA steps in, showing the income earned above those funding costs.

SVA offers several advantages you might appreciate. It uses NOPAT based on operating profits, excluding tax savings from debt, which strips out financing decisions' impact and allows true comparisons between companies, no matter their financing strategies.

Additionally, NOPAT leaves out extraordinary items, making it a more accurate gauge than net profit for a company's ability to produce profits from regular operations. These extraordinary items could include restructuring costs or other one-off expenses that might skew profits temporarily.

Formula for Shareholder Value Added (SVA)

The formula for SVA is simple: SVA equals NOPAT minus CC, where NOPAT is net operating profit after tax, and CC is the cost of capital.

Shareholder Value Added in Value Investing

SVA hit its peak popularity in the 1980s, when corporate managers and boards faced criticism for prioritizing personal or company gains over shareholders. Today, the investment community doesn't hold it in such high esteem.

Value investors focusing on SVA often prioritize short-term returns above the market average, rather than longer-term gains. This is built into the SVA model, which penalizes companies for capital costs tied to business expansion. Critics argue this pushes companies toward shortsighted choices instead of customer satisfaction.

In essence, these investors are frequently seeking cash value added, or CVA. Companies generating substantial cash from operations can offer higher dividends or display stronger short-term profits, but this is just a side effect of real productivity or wealth creation.

Real investments typically demand heavy capital spending and can lead to short-term losses, especially in our innovation-driven digital era with big tech investments and experimentation. Consider blitz-scaling as the antithesis of SVA—it ignores short-term losses entirely in favor of long-term value creation.

Stockholders always demand maximum returns, dividends, and profits from their corporations. If you're a value investor, be cautious not to get shortsighted by overemphasizing SVA and neglecting the long-term risks of underinvestment.

Limitations of Shareholder Value Added

One primary limitation of SVA that you should be aware of is its difficulty in calculation for privately held companies. It requires determining the cost of capital, including the cost of equity, which is challenging for private firms.