What Is Shareholder Value Added – SVA?

Shareholder value added (SVA) is a measure of the operating profits that a company has produced in excess of its funding costs, or cost of capital. The basic calculation is net operating profit after tax (NOPAT) minus the cost of capital, based on the company's weighted average cost of capital.

Some value investors use SVA as a tool to judge the corporation's profitability and management efficacy. This line of thinking runs congruent with value-based management, which assumes that the foremost consideration of a corporation should be to maximize economic value for its shareholders.

The Formula for Shareholder Value Added Is

SVA=NOPATCCwhere:NOPAT=Net operating profit after taxCC=Cost of capital\begin{aligned} &\text{SVA} = \text{NOPAT} - \text{CC} \\ &\textbf{where:} \\ &\text{NOPAT} = \text{Net operating profit after tax} \\ &\text{CC} = \text{Cost of capital} \\ \end{aligned}SVA=NOPATCCwhere:NOPAT=Net operating profit after taxCC=Cost of capital

What Does Shareholder Value Added Tell You?

Shareholder value is created when a company's profits exceed its costs. But there is more than one way to calculate this. Net profit is a rough measure of shareholder value-added, but it does not take into account funding costs, or the cost of capital. Shareholder value added (SVA) shows the income that a company has earned in excess of its funding costs.

Shareholder value added has a number of advantages. The SVA formula uses NOPAT, which is based on operating profits and excludes the tax savings that result from the use of debt. This removes the effect of financing decisions on profits and allows for an apples-to-apples comparison of companies regardless of their financing method.

NOPAT also excludes extraordinary items and is thus a more precise measure than the net profit of a company's ability to generate profits from its normal operations. Extraordinary items include restructuring costs and other one-time expenses that may temporarily affect a company's profits.

Key Takeaways

  • Shareholder value added (SVA) is a measure of the operating profits that a company has produced in excess of its funding costs, or cost of capital.
  • The SVA formula uses NOPAT, which is based on operating profits and excludes the tax savings that result from the use of debt.
  • A prime disadvantage of shareholder value added is that it is difficult to calculate for privately held companies.

SVA in Value Investing

The popularity of SVA reached a peak during the 1980s as corporate managers and boards of directors came under scrutiny for focusing on personal or company gains rather than focusing on shareholders. SVA is no longer held in such high regard by the investment community.

Value investors who focus on SVA are more concerned with generating short-term returns above market average than with longer-term returns. This trade-off is implicit in the SVA model, which punishes companies for incurring capital costs in an attempt to expand business operations. Critics counter that these value investors are driving companies towards making shortsighted decisions rather than focusing on satisfying their customers.

In a sense, investors who focus on SVA are often actually looking for cash value added (CVA). Companies that generate a lot of cash through their operations can pay higher dividends or show greater short-term profits. This is only a proximate effect of actual productivity or wealth creation, however. Real investments often require intense capital expenditures and short-term losses.

Stockholders always want their corporations to maximize returns, pay dividends, and show profits. Value investors can risk becoming shortsighted by focusing only on SVA and not considering the long-term implications of too little reinvestment.

Limitations of Shareholder Value Added

A prime disadvantage of shareholder value added is that it is difficult to calculate for privately held companies. SVA requires calculating the cost of capital, including the cost of equity. This is difficult for companies that are privately held.