Value : The Four Cornerstones of Corporate Finance

From the team behind Valuation--the #1 bestselling reference on corporate finance--comes a decision-making guide for all executives to use as they create, manage, and sustain shareholder value.

Corporate leaders are regularly confronted with conventional wisdom and half-truths about value creation. They're given conflicting advice about what will or won't appeal to investors, often contradicting their own judgment about what builds lasting worth in their companies and the economy.



In Value: The Four Cornerstones of Corporate Finance, partners from the management consulting firm of McKinsey & Company describe the basic principles of value creation and their relevance. Internalizing these principles--or cornerstones--gives decision makers the independence and courage they need to challenge conventional wisdom, defy half-truths, and build thriving businesses.



The four cornerstones are:



The Core of Value: a business's value is driven by its growth and return on capital, and resulting cash flows



The Conservation of Value: value is created when companies generate higher cash flows, not by simply rearranging investors' claims on cash flows



The Expectations Treadmill: movements in company share prices reflect changes in the stock market's expectations, not just underlying performance



The Best Owner: the value of a business is not an absolute but, rather, depends on who is managing it and the strategy pursued



While there are many books that cover selected topics within corporate finance--often for specialized practitioners--it's the rare book that offers leaders a unifying viewpoint of business. Value is that book.
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Praise for VALUE

"Value will help senior leaders and their boards act on bold ideas for creating value in the businesses they lead. The four principles of value creation are a concise guide to growing and shaping companies."
--Ed Breen, Chairman and Chief Executive Officer, Tyco International Ltd.



"In a complex business world, we shouldn't overlook the relatively simple financial principles that underlie the creation of long-term shareholder value. This book gives corporate leaders a clear base of knowledge for creating and sustaining value under any economic, industry, or company circumstances."
--Dominic J. Caruso, Chief Financial Officer, Johnson & Johnson



"More than a handbook, this is the bible of value creation. It should be read by corporate leaders across the entire spectrum. It also reminds us not to ignore the abiding financial principles that guide companies to long-term value creation."
--Stefan Krause, Chief Financial Officer, Member of the Management Board, Deutsche Bank AG



"A valuable source of guidance for business leaders who are focused on creating real, lasting value."
--Mark Loughridge, Senior Vice President and Chief Financial Officer, Finance and Enterprise Transformation, IBM Corporation



"A very useful, no-nonsense guide for creating shareholder value. Competition, capital structure, acquisitions, buybacks, dividends, and more--it's all here with straightforward principles and examples."
--Keith S. Sherin, Vice Chairman and Chief Financial Officer, General Electric Company



"If more owners and executives had the overriding objective of long-term value creation--and enough knowledge about how to create it--then our financial world would be a more stable one."
--Rajiv Singh, Vice Chairman, DLF Limited



"Value cuts through clutter and myopia to provide a sound foundation for leaders who are building enterprises that thrive and serve society."
--Daniel Vasella, MD, Chairman, Novartis AG
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About the Authors ix Preface xi Acknowledgments xv Part One The Four Cornerstones 1 Why Value Value? 3 Many companies make decisions that compromise value in the name of creating value. But with courage and independence, executives can apply the four cornerstones of finance to make sound decisions that lead to lasting value creation. 2 The Core of Value 15 Return on capital and growth are the twin drivers of value creation, but they rarely matter equally. Sometimes raising returns matters more, whereas other times accelerating growth matters more. 3 The Conservation of Value 29 You can create the illusion of value or you can create real value. Sometimes acquisitions and financial engineering schemes create value, and sometimes they don t. No matter how you slice the financial pie, only improving cash flow creates value. 4 The Expectations Treadmill 41 No company can perpetually outperform the stock market s expectations. When a company outperforms, expectations rise, forcing it to do better just to keep up. The treadmill explains why the share prices of high performing companies sometimes falter, and vice versa. 5 The Best Owner 51 No company has an objective, inherent value. A target business is worth one amount to one owner and other amounts to other potential owners depending on their relative abilities to generate cash flow from the business. Part Two The Stock Market 6 Who Is the Stock Market? 63 Conventional wisdom segments investors into pigeonholes like growth and value, but these distinctions are erroneous. There s a more insightful way to classify investors, and doing so culls out those who matter most to the value-minded executive. 7 The Stock Market and the Real Economy 73 The performance of stock markets and real economies are typically aligned, hardly ever perfectly aligned, and rarely very misaligned. Executives and investors who understand this are better able to make value-creating decisions. 8 Stock Market Bubbles 89 Stock market bubbles are rare and usually confined to specific industry sectors and companies. Knowing why and when bubbles occur can keep management focused on making sound strategic decisions based on a company s intrinsic value. 9 Earnings Management 103 Trying to smooth earnings is a fool s game that can backfire and, in some cases, destroy value. Creating value in the longer run sometimes necessitates decisions that reduce earnings in the shorter run. Part Three Managing Value Creation 10 Return on Capital 119 A company can t sustain a high return on capital in the absence of an attractive industry structure and a clear competitive advantage. Yet it s surprising how few executives can pinpoint the competitive advantages that drive their companies returns. 11 Growth 139 It s difficult to create value without growing, but growth alone doesn t necessarily create value. It all depends on what type of growth a company achieves and what the returns on that growth are. 12 The Business Portfolio 153 A company s destiny is largely synonymous with the businesses it owns, and actively managed portfolios outperform passively managed portfolios. Sometimes companies can create value by selling even high performing businesses. 13 Mergers and Acquisitions 169 Most acquisitions create value, but typically the acquirer s shareholders only get a small portion of that value, while the lion s share goes to the target s shareholders. But there are archetypal ways that acquirers can create value. 14 Risk 183 Nothing in business is more clear yet complex than the imperative to manage risk. Clear because risk matters greatly to the company, its board, its investors, and its decision makers. Complex because each of these groups has a different perspective. 15 Capital Structure 197 Getting capital structure right is important but doesn t necessarily create value while getting capital structure wrong can destroy tremendous value. When it comes to financial structures, companies are best to keep them as simple as possible. 16 Investor Communications 209 Good investor communications can ensure that a company s share price doesn t become misaligned with its intrinsic value. And communication isn t just one way: executives should listen selectively to the right investors as much as they tell investors about the company. 17 Managing for Value 223 It s not easy to strike the right balance between shorter-term financial results and longer-term value creation especially in large, complex corporations. The trick is to cut through the clutter by making your management processes more granular and transparent. Appendix A The Math of Value 237 Appendix B The Use of Earnings Multiples 241 Index 245
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'...marches the reader through the very practical issues that affect value.' (Financial Times, November 2010).
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marches the reader through the very practical issues that affect value. (Financial Times, November 2010).
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McKINSEY & COMPANY is a global management consulting firm that helps leading private, public, and social-sector organizations make distinctive, lasting, and substantial performance improvements. With consultants deployed from more than ninety offices in over fifty countries, McKinsey advises companies on strategic, operational, organizational, financial, and technological issues. TIM KOLLER leads the firm's research activities in valuation and capital market issues. He advises clients globally on corporate strategy, capital markets, M&A, and value-based management. Tim is a coauthor of Valuation: Measuring and Managing the Value of Companies. RICHARD DOBBS is a director of the McKinsey Global Institute, the firm's business and economics research arm. He advises Korean and other Asian companies and governments on strategy, economics, and M&A issues. Richard is an associate fellow of University of Oxford's Said Business School. BILL HUYETT advises clients in healthcare and other technology-intensive industries on corporate strategy, M&A, product development and commercialization, and corporate leadership. Bill is active on several not-for-profit boards in basic life sciences research.
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