A:

There are numerous ways that investors and lenders can estimate the value of a company. This becomes increasingly important for individuals seeking out value investing opportunities in small and large companies. Valuations can also be used to determine whether a business is a good credit risk.

The most-common metrics used to determine a company's value include economic value added and market value added. However, there are distinct differences between these two valuation strategies, and investors need to be aware of how to use each.

What Is Economic Value Added?

Economic value added (EVA) is a performance measure developed by Stern Stewart & Co. (now known as Stern Value Management) that attempts to measure the true economic profit produced by a company. It is frequently also referred to as "economic profit," and provides a measurement of a company's economic success (or failure) over a period of time. Such a metric is useful for investors who wish to determine how well a company has produced value for its investors, and it can be compared against the company's peers for a quick analysis of how well the company is operating in its industry.

Economic profit can be calculated by taking a company's net after-tax operating profit and subtracting from it the product of the company's invested capital multiplied by its percentage cost of capital.

For example, if a fictional firm, Cory's Tequila Company (CTC), had 2017 net after-tax operating profits of $200,000 and invested capital of $2 million at an average cost of 8.5 percent, then CTC's economic profit would be computed as $200,000 - ($2 million x 8.5%) = $30,000.

This $30,000 represents an amount equal to 1.5 percent of CTC's invested capital, providing a standardized measure for the wealth the company generated over and above its cost of capital during the year.

Additionally, EVA takes into account the opportunity cost of alternative investments while other valuation techniques do not. A company's profitability can be gauged by calculating EVA, as its focus is on a business project's profitability and therefore the efficiency of company management.

What Is Market Value Added?

Market value added (MVA), on the other hand, is simply the difference between the current total market value of a company and the capital contributed by investors (including both shareholders and bondholders). It is typically used for companies that are larger and publicly-traded. MVA is not a performance metric like EVA, but instead is a wealth metric, measuring the level of value a company has accumulated over time.

As a company performs well over time, it will retain earnings. This will improve the book value of the company's shares, and investors will likely bid up the prices of those shares in expectation of future earnings, causing the company's market value to rise. As this occurs, the difference between the company's market value and the capital contributed by investors (its MVA) represents the excess price tag the market assigns to the company as a result of it past operating successes.

Unlike EVA, MVA is a simple metric of the operational capability of a business and, as such, does not incorporate the opportunity cost of alternative investments.

(To learn more, read the Economic Value Added Tutorial and All About EVA.)

RELATED FAQS
  1. What is the difference between economic value and market value?

    Learn about the differences between economic value and market value. Discover how they serve different purposes for businesses ... Read Answer >>
  2. What is the difference between market capitalization and market value?

    Understand the difference between market capitalization and market value, including the elements used for the calculation ... Read Answer >>
  3. How Are Book Value and Intrinsic Value Different?

    Book value and intrinsic value are two ways to measure the value of a company. Find out which is known as the true value ... Read Answer >>
  4. What is the difference between enterprise value and equity value?

    Valuating a business accurately depends heavily on the purpose of the valuation. Learn how enterprise value and equity value ... Read Answer >>
Related Articles
  1. Investing

    Understanding Economic Value Added (TM)

    Discover the simplicity of Economic Value Added (TM), also known as economic profit.
  2. Investing

    Investment Value Vs. Fair Market Value: How They Differ

    Learn about the differences between an asset's investment value and its fair market value, including why many think fair market value is unrealistic.
  3. Investing

    Peer Comparison Uncovers Undervalued Stocks

    Learn how to put one of the top equity analysis tools to work for you.
  4. Investing

    A Guide to Value Investing Strategies

    Learn the value investing techniques that legendary investors like Warren Buffett and Peter Lynch have used to identify undervalued companies that pay off.
  5. Investing

    Methods used in valuing private companies

    There are a few methods for calculating the valuation of a private company. By using financial information from peer groups, we can estimate the valuation of a target firm.
  6. Investing

    Equity Valuation In Good Times And Bad

    Learn how to filter out the noise of the market place in order to find a solid way of determing a company's value.
  7. Investing

    3 Red Flags for Value Stocks (KMI, FCX)

    Assess the components of Warren Buffett's value investing technique, and analyze the additional financial metrics to consider when diving into today's market.
RELATED TERMS
  1. Cash Value Added - CVA

    Cash value added is a measure of company's ability to generate ...
  2. Economic Capital

    Economic capital is the amount of capital that a firm, usually ...
  3. Mid-Cap Value Stock

    A Mid-Cap Value Stock is shares of a company with a medium market ...
  4. Equity Market Capitalization

    Equity market capitalization is the measure of the total market ...
  5. Market Value Of Equity

    Market value of equity is the total dollar value of a company's ...
  6. Relative Value

    Relative value is a method of determining an asset or company's ...
Hot Definitions
  1. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  2. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  3. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  4. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  5. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  6. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
Trading Center