What is 'Shareholder Value'
Shareholder value is the value delivered to shareholders because of management's ability to grow sales, earnings and free cash flow over time. A company’s shareholder value depends on strategic decisions made by senior management, including the ability to make wise investments and generate a healthy return on invested capital. If this value is created over the long term, the share price increases and the company can pay larger cash dividends to shareholders.
BREAKING DOWN 'Shareholder Value'
Increasing shareholder value increases the total amount in the stockholders' equity section of the balance sheet. The balance sheet formula is assets less liabilities equals stockholders' equity, and stockholders' equity includes retained earnings, or the sum of a company's net income less cash dividends since inception.
Factoring in Earnings Per Share
If management makes decisions that increase net income each year, the company can either pay a larger cash dividend or retain earnings for use in the business. A company’s earnings per share (EPS) is defined as earnings available to common shareholders divided by common stock shares outstanding, and the ratio is a key indicator of a firm’s shareholder value. When a company can increase earnings, the ratio increases and investors view the company as more valuable.
How Asset Use Drives Value
Companies raise capital to buy assets and use those assets to generate sales. A well-managed company maximizes the use of its assets so the firm can operate the business with a smaller investment in assets. Assume, for example, a plumbing company uses a truck and equipment to complete residential plumbing work and the total cost of these assets is $50,000. The more sales the plumbing firm can generate using the truck and the equipment, the more shareholder value the business creates. Valuable companies can generate increasing earnings with the same dollar amount of assets.
Instances Where Cash Flow Increases Value
Generating sufficient cash inflows to operate the business is also an important indicator of shareholder value, because the company can operate the business and increase sales without the need to borrow money or issue more stock. Firms can increase cash flow by quickly converting inventory and accounts receivable into cash collections. The rate of cash collection is measured by turnover ratios, and companies attempt to increase sales without the need to carry more inventory or increase the average dollar amount of receivables. A high rate of both inventory turnover and accounts receivable turnover increases shareholder value.