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.

RELATED TERMS
  1. Shareholder Equity Ratio

    A ratio used to help determine how much shareholders would receive ...
  2. Invested Capital

    The total amount of money that was endowed into a company by ...
  3. Balance Sheet

    A balance sheet reports a company's assets, liabilities and shareholders' ...
  4. Common Shareholder

    The rights of common shareholders give them the ability to influence ...
  5. Cash Flow

    Cash flow is the net amount of cash and cash-equivalents being ...
  6. Valuation

    The process of determining the current worth of an asset or company. ...
Related Articles
  1. Investing

    Analyze cash flow the easy way

    Learn the key components of the cash flow statement, how to analyze and interpret changes in cash, and what improved free cash flow means to shareholders.
  2. Investing

    Asset Turnover Ratio

    Investopedia explains: The asset turnover ratio is a measure of a company's ability to use its assets to generate sales or revenue, and is a calculation of the amount of sales or revenue generated ...
  3. Investing

    What Does Negative Shareholder Equity On A Balance Sheet Mean?

    Negative shareholder equity on a company’s balance sheet is a red flag that should prompt potential investors to take a closer look before committing their money.
  4. Investing

    Free cash flow yield: The best fundamental indicator

    Cash in the bank is what every company strives to achieve. Find out how to determine how much a company is generating and keeping.
  5. Investing

    Operating Cash Flow: Better Than Net Income?

    Differences between accrual accounting and cash flows show why net income is easier to manipulate.
  6. Investing

    The Difference Between Enterprise Value and Equity Value

    Enterprise value calculates a business’s current value, while equity value offers a snapshot of that business’s current and potential future value.
  7. Investing

    What Is a Cash Flow Statement?

    The Cash Flow Statement measures whether a company generates enough cash to meet its operating expenses.
RELATED FAQS
  1. How do you calculate shareholder equity?

    Shareholder equity is calculated by subtracting a company's total liabilities from its total assets. It's the amount remaining ... Read Answer >>
  2. Cash Dividends or Stock Dividends: Which is better?

    The purpose of dividends is to return wealth back to the shareholders of a company. There are two types of dividends: cash ... Read Answer >>
Hot Definitions
  1. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  2. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  3. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  4. Dividend

    A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
  5. Inventory Turnover

    Inventory turnover is a ratio showing how many times a company has sold and replaces inventory over a period.
  6. Watchlist

    A watchlist is list of securities being monitored for potential trading or investing opportunities.
Trading Center