Shareholder Value - Explained
What is Shareholder Value?
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What is Shareholder Value?
Shareholder value is the Shareholders' financial worth in a company. Shareholder value may go up due to the overall success of the company leading to an increase in their capital gains and dividends. A company may have an increase in earnings, sales, and cash flows over a long period. The board of directors of a company is responsible for deciding the strategies that the corporation will use to generate higher capital returns. If the returns on investments and capitals are high, then the company can pay its shareholders more dividends. Some changes in cash flows may also decrease, leading to a decrease in shareholder value.
How does Shareholder Value Work?
Shareholder value happens where the management team of a company is able to apply smart business decisions. Smart decisions help the company to increase shareholder value by increasing the share price, earnings, and dividends. Generally, the managements prime role is to increase shareholder value. So, any company's management must strive to ensure that the shareholder's interests are put into consideration when making decisions. Higher shareholder value is, therefore, beneficial to both the company as well as the management.
Calculating Shareholders Value
The major goal of investors is to generate higher returns from what they have invested. For this reason, investors should be able to calculate their shareholder value. Below are four steps of calculating shareholder value:
- Step 1: Step one involves subtraction of preferred dividends of the company from its net income. Preferred dividends refer to dividends that a company pays its preferred stockholders. Net income, on the other hand, is the total earnings of the company after subtracting depreciation, operating and non-operating expenses, taxes, and interest.
- Step 2: Step two involves the computation of the earnings of the company by share. To compute this, you will be required to divide the available income of the company by its overall outstanding shares.
- Step 3: In step three, you are required to add the price of the stock to per-share earnings. For instance, lets assume that a company is selling its stock at $40 for every share. In this case, you will have to add $40 as well as the earnings, which in this case are $2 per share to get $42.
- Step 4: In this stage, you are required to multiply the total arrived at in stage three by the total number of shares an individual shareholder holds. For instance, lets assume that a shareholder holds 10 shares. In this case, this particular shareholder will have a shareholder value of $142 ($42 x 10 = $142).
How to Create Shareholder Value
To increase profitability and maximize shareholder value, the company can implement three strategies. The strategies include:
Revenue growth The company can increase its revenue from goods and services by increasing the volume of sales or through price inflation. Any existing company would want the consumers to stick to using their brand products and not deviate to the competing brands. The company should ensure that the brand recognition in the market and the value they give consumers is unmatched. The company can make use of different promotional strategies to attract new customers to its products. They can also improve the products they have or come up with new products. By doing this, the company may get loyal customers while still increasing their revenues. A company can also increase the prices of its products to generate more revenue. Price increments can go together with the production of new products. The company creates new quality products which are then priced different from the old ones. The company can use the volume of sales and price inflations at the same time.
Operating Margin The company can also increase profitability by reducing its operating costs and total expenses. Building a good company-supplier relationship is beneficial to the company. The company may receive discounts from suppliers whenever they make large orders. Negotiations may also help the company reduce the cost of buying production materials. The use of automation methods to manufacture products delivers quality products and reduces return rates of defective products. The management team needs to use effective strategies to ensure the processes cost less but do not affect quality. The largest expenses in a company are from sales, administration, and general payments of labor. When it reduces this, then they can achieve an operating margin. The company can reduce its marketing budget and cut down any unnecessary labor costs.
Capital efficiency Capital efficiency shows how the company is using its capital in daily operations and the profits they generate. The use of capital to generate profits should be higher than the company's expenses. Profits = total assets liabilities
Limitation of maximizing shareholder value
Shareholder value brings about conflicts in companies. As much as the equity funds of shareholders increase their value, it does not equate to value for customers and employees in the company. The shareholders seem to be creating wealth, but the employees remain stagnant. The Chief Executive officers of most companies also agree that shareholder value maximization cannot be the main goal of a company. They say it can slow down the company's productivity, bring about inequalities in growth, lead to financial crashes, and cause distrust in the business.
People understand stakeholder value differently. Some believe that the company directors have a legal obligation to increase company profits to improve shareholder value. However, this does not hold as this is general wisdom. The law does not tie any company to increase shareholder value. The strategies the company uses will determine if it will generate interests or not.