The Future Is Now

In analyzing a company’s stock price, executives may be seeing only part of the picture. We have devised an approach that allows executives to gain a clear outlook on both the current and future components of their company’s share price. ​Executives have become increasingly sophisticated in the past couple of decades at analyzing the value of current operations and at using that analysis to help them manage with the goal of increasing shareholder value. But they still need to supplement the well-developed tools they use for value-based management with one that can analyze their company’s future value, the portion of the share price that isn’t based on the earnings from current operations or products.

Imagine you are the CEO of a company that has just enjoyed a year of record sales and earnings. In your annual letter to shareholders, you assure investors that the company’s health and growth prospects have never been stronger. And yet you’ve seen the company’s share price drop 5% over the past year, even as competitors’ stocks gained 10%. Worse, the scenario replays itself the following year: Profit margins and profits again increase, but the stock price treads water while rivals’ shares rack up impressive gains. 
The problem is a common one: The boost that outstanding current performance gives to shareholder value can be offset when investors’ faith in a company’s future begins to evaporate. To avoid this nightmare, executives need a complete picture of both these components of their business’s value. 

How important is future value to share prices in concrete terms? As an example, an analysis by AssetEconomics Inc. of the companies in the Russell 3000 Index as of May 2003 found that future-value expectations represented 59% of their overall enterprise value—the market value of a company’s equity plus the net value of its interest-bearing debt obligations. In 12 of 22 industry groups analyzed, future value made up more than half of enterprise value.  To put those figures into dollar terms, approximately $7.6 trillion of the Russell 3000’s total enterprise value of $13 trillion was bound up in future value. And that was three years after the market began correcting itself for the inflated expectations of the dot-com bubble. Even in 2006,
after corporate profits—and therefore current value—had risen significantly over a three-year period, some $6.6 trillion of the Russell 3000’s total enterprise value of $19.5 trillion, or about one-third, was represented by future value.
What investors are doing here is placing a significantly higher value on these companies than would seem warranted by the success of their current operations. They are saying, in effect, «We see that your current operations are worth such-and-such, but we’re going to reward you well above that level because we have faith in your growth prospects.» That extra amount investors are willing to pay is the company’s future value. Mathematically, it can be calculated for any company by subtracting current value from the business’s overall enterprise value. So, start with enterprise value, which again is the market value of a company’s equity plus the net value of its interest-bearing debt obligations. Then subtract current value, which is after-tax operating profit divided by the weighted average cost of capital. The result is future value. 

*By ROLAND J. BURGMAN, DAVID J. ADAMS, DAVID A. LIGHT and JOSHUA B. BELLIN