Glaxos Economic Value Added Drops 19.23% In 1999

Is there a link between economic value added (EVA) of a company and its market capitalisation? It seems so, if Glaxo India's case is anything to go by.

Glaxo's economic value added (EVA) decreased by 19.23 per cent to Rs 54.52 crore in the year ended December 31, 1999, from Rs 67.50 crore in 1998. The company had recorded an eye-catching EVA growth of 76.65 per cent in 1998.

The company's market capitalisation moved more or less on similar lines. In 1999, its market capitalisation grew at a slower rate of nearly 23 per cent against about 54 per cent in 1998.

 

To confirm this finding statistically, we calculated the correlation between EVA and market capitalisation. The positive correlation between the two was as high as 0.8004.

EVA _ devised by the consulting firm, Stern Stewart _ is one of the best available tools to measure the returns earned by a company or a firm in excess of the minimum expected return of the shareholders and lenders.

It is a very popular model currently among companies across a board spectrum of industries and across a wide range of countries.

EVA is determined statistically as net operating profit after tax (Nopat) and depreciation but before interest minus the cost of capital employed. Cost of capital employed is the weighted average cost of capital multiplied by average capital employed.

It can be said that EVA is the value added to the shareholders by generating return in excess of the cost of capital employed in the business.

Incidentally, according to a study of International Labour Organisation (ILO), value-added productivity index (VAP) measured with a long time-series data and by the ratio of value added to wages, depreciation and interest, is superior among the different productivity measures as it affords a scientific assessment of the efficiency of an individual unit.

In line with the ILO, Glaxo's value-added productivity (VAP) was calculated linked with the company's market capitalisation. There was a positive correlation between VAP, but it was as low as 0.2733. This could be due to the short time of this study.

Another professional services firm, PricewaterhouseCoopers (PwC), has developed a proprietary tool called ValueBuilder and claimed to be the better tool than EVA to understand the influence of various factors on shareholder value. A number of financial analysts argue in favour of more than one yardstick to determine the potential for investment in a company's stock.

So, in this study-series of factors affecting market capitalisation, we have tried to find out the relationship between market capitalisation and economic value added (EVA) and value-added productivity (VAP) of different companies. We have not tried here the ValueBuilder concept of PwC as the full text of the tool is yet to be received by us.

We have selected Glaxo India to be the first company for our study as it has already released full annual report for the year end December 31, 1999.

Growth Of Market Capitalisation And Eva

Years ended March 31

Items 1996 1997 1998 1999

Sales 645.01 696.01 793.84 885.50

EVA 34.67 38.21 67.50 54.52

NOPAT 59.73 66.90 95.88 87.96

Cost of cap 25.06 28.69 28.38 33.44

VAP 1.87 1.82 2.14 1.84

M. caps. 1,565.97 2,319.26 3,566.77 4,386.22

EPS (Rs) 8.31 9.31 14.49 12.89

Per cent change

Items 1997 1998 1999

Sales 7.91 14.06 11.55

EVA 10.22 76.65 -19.23

NOPAT 12.00 43.32 -8.26

Cost of cap 14.47 -1.07 17.82

VAP -2.88 17.96 -14.12

M. caps. 48.10 53.79 22.97

EPS (Rs) - - -

Correlation between M.cap & EVA 1996 to 1999 r=0.80039

Correlation between M.cap & VAP 1996 to 1999 r=0.27328