Finance
by Tim Koller, Marc Goedhart and David Wessels
What is a company really worth?
Share prices jump on every earnings report. Tim Koller, Marc Goedhart and David Wessels, writing for McKinsey, argue that underneath the noise a company is worth the cash it will generate in future, discounted back to today. Their textbook shows how to measure that, and how managers can raise it.
Hear a sample · read by Laura
Two things set a company's value. One is growth. The other is return on invested capital, or ROIC, the profit it earns on the money tied up in the business. Growth adds value only when ROIC beats the cost of capital. Below that, growing faster makes the company worth less.
If a move doesn't change the cash a business will produce, it doesn't change what the business is worth. The authors put share buybacks, most financial engineering and accounting choices in this group. They can shift value between investors, but they can't make more of it.
Their main tool is discounted cash flow. Forecast free cash flow, the cash left after the investment the business needs, and discount it at the weighted average cost of capital. The years beyond the forecast become one figure, the continuing value, often a large share of the total.
Plenty of executives believe investors care only about next quarter's earnings. The authors disagree. They find that share prices, across the market, follow long-term returns and growth, and that cutting sound investment to hit a short-term earnings target destroys value.
Returns
Value comes from earning more on capital than it costs, and growing while you do it.
Growth alone
Growth only adds value when returns beat the cost of capital. Below that, growing destroys value.
Real cash
Shifting profit around on paper doesn't change what a company is worth. Only real cash flows do.
Expectations
A share price moves on how results compare with what investors already expected.
Long view
Managers who chase this quarter's earnings at the cost of future cash end up hurting value.
Hot take · true or myth?
A conglomerate spreads its risk, so investors should value it more highly.
Myth. Investors can spread risk themselves by owning many shares. The authors say diversification inside one company doesn't lower its cost of capital, so it adds no value on its own.
One thing to try
Pick a business you know well, such as a side project or your employer. Divide its yearly profit after tax by the money tied up in it. Then ask whether that beats what the money could earn elsewhere at similar risk. If not, the authors would say growth destroys value.
Knotd has the key ideas from 250+ non-fiction books, each in a few minutes, in plain words. Valuation: Measuring and Managing the Value of Companies comes with a Hot Take round and a Name That Idea round to make it stick.
Get the whole book on KnotdOpen in the appWhat is a company really worth? Share prices jump on every earnings report. Tim Koller, Marc Goedhart and David Wessels, writing for McKinsey, argue that underneath the noise a company is worth the cash it will generate in future, discounted back to today. Their textbook shows how to measure that, and how managers can raise it.
Returns and growth; The conservation of value; Cash flow, discounted; Markets look past the quarter.
Pick a business you know well, such as a side project or your employer. Divide its yearly profit after tax by the money tied up in it. Then ask whether that beats what the money could earn elsewhere at similar risk. If not, the authors would say growth destroys value.
Yes. Knotd has the key ideas from Valuation: Measuring and Managing the Value of Companies in a few minutes, in plain words, plus a Hot Take round and a Name That Idea round to test them. It's one of 250+ non-fiction books in the app.
