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NEWS
Henley offers scholarships to investigative journalists
Henley offers scholarships to investigative journalists

5 trends that can keep the South African MBA relevant
5 trends that can keep the South African MBA relevant

We need to realign government, business and civil society
We need to realign government, business and civil society

Life as a full-time MBA student
Life as a full-time MBA student

Brexit delay provides breathing space for SA
Brexit delay provides breathing space for SA

MSA joins the ADvTECH family
MSA joins the ADvTECH family

SA plunges to 117 out of 149 in gender wage equality
SA plunges to 117 out of 149 in gender wage equality

UCT’s Executive MBA recognised for its distinctive approach
UCT’s Executive MBA recognised for its distinctive approach

GIBS Executive MBA programme debuts in top 50
GIBS Executive MBA programme debuts in top 50

Can Africa fill the glass?
Can Africa fill the glass?

YALI AFRICA launch at Unisa
YALI AFRICA launch at Unisa

The fake resurrection of South Africa
The fake resurrection of South Africa

Don't panic: The digital revolution isn’t that unusual
Don't panic: The digital revolution isn’t that unusual

Why Agile works
Why Agile works

How firms can avoid the mediocrity trap
How firms can avoid the mediocrity trap

How a 100000-strong company is relearning how to innovate
How a 100000-strong company is relearning how to innovate

The changing shape of the MBA
The changing shape of the MBA

Adding climate change to curriculum is a top priority
Adding climate change to curriculum is a top priority

The MBA should turn you into a business disruptor
The MBA should turn you into a business disruptor

Innovation in SA organisations driven by C-level support
Innovation in SA organisations driven by C-level support

UNISA SBL a torch-bearer of training for military veterans
UNISA SBL a torch-bearer of training for military veterans

Scaling up the MBA for relevance in the 4IR
Scaling up the MBA for relevance in the 4IR

Moody's: SA not out of the woods yet
Moody's: SA not out of the woods yet

GIBS manufacturing-focused MBA kicks off in Durban
GIBS manufacturing-focused MBA kicks off in Durban

Henley’s Makhoalibe selected for sought-after programme
Henley’s Makhoalibe selected for sought-after programme

Personal potential, a source of power
Personal potential, a source of power

Reach your business leadership potential with a MBA from WBS
Reach your business leadership potential with a MBA from WBS

MPC: SA needs a period of stable interest rates
MPC: SA needs a period of stable interest rates

SA’s energy problems just the tip of the iceberg
SA’s energy problems just the tip of the iceberg

What's really driving disruption?
What's really driving disruption?

Why has there been such a failure of leadership?
Why has there been such a failure of leadership?

Steinhoff: Exactly where does responsibility stop and start?
Steinhoff: Exactly where does responsibility stop and start?

The cure for the loneliness of command
The cure for the loneliness of command

How to survive in the age of digital transformation
How to survive in the age of digital transformation

New MBA timetable starts in 2016
New MBA timetable starts in 2016

EVENTS
Henley MBA & PGDIP Preview Day
Henley MBA & PGDIP Preview Day
29 May 2019,
Pretoria

UCT GSB MBA Information Sessions
UCT GSB MBA Information Sessions
15 October 2019,
Johannesburg



06 NOVEMBER 2018
To appreciate value, we have to look beyond earnings
Every student of finance is taught that rising profits do not necessarily reflect good strategic decision-making, or the creation of long-term economic value. That only happens when companies invest in strategies where the return on capital exceeds its cost. So says David Holland, adjunct professor at the UCT Graduate School of Business who teaches Company Valuation on the MBA programme.

Writing in his new book, Beyond Earnings, co-authored with Bryant A Matthews, Holland argues that strategy and finance should be joined at the hip in company planning. “The purpose of a firm isn’t to maximise short-term earnings, but rather to build a sustainable competitive advantage,” he says.

Sometimes this might mean investing in long-term strategies that could hurt earnings in the short-term.

“For example, Amazon’s net income has been meagre for decades only because accounting standards classify R&D as an expense, not an investment,” Holland says. “Amazon Web Services, one of its most profitable businesses, would not exist if CEO Jeff Bezos had focussed on earnings management instead of investing in future value creation.”

Unfortunately, many management teams are given incentives to grow accounting profits, which is relatively easy to do. They can buy back shares, take on risky levels of debt, and invest in projects that generate earnings but destroy value, such as acquisitions made at steep premiums.

“The financial press is littered with reports of write-downs and problems digesting foreign acquisitions,” Holland notes. “Recent examples are Woolworths’ purchase of Australian retailer David Jones, and Famous Brands' buyout of Gourmet Burger Kitchen in the UK.”

Steinhoff too had an insatiable hunger for takeovers. While these activities may have increased its accounting earnings, they resulted in negative free cash flows and destroyed shareholder value.

Asking the right questions about the allocation of capital

Instead of earnings, operating profit, or earnings growth, managers should be incentivised to increase economic profit. Although this might sound like a subtlety, Holland shows it is not. Economic profit is what is left after the cost of capital has been taken into account.

“The biggest issue with an income statement is that there is no charge on shareholder's equity, which is not free,” Holland argues. “Economic profit aligns the income statement, which shows earnings growth, with the balance sheet, showing capital discipline.”

Valuing an enterprise this way is based on long-term expectations.

“If you look at the valuations of many successful companies, they are priced to maintain a high return on capital for a long time into the future,” Holland says. “Clicks is a world-class company that generates an impressive and stable return on capital which attracts local and foreign investors. There is a lot more to ensuring that the long-term expectations of these investors are met than just finding ways to maximise earnings.”

For instance, if the company fails to train its staff properly, treats its customers poorly, or flouts regulations, it will lose business. While this would certainly be bad for shareholders, it would also affect employees, customers and all other stakeholders. It is therefore clearly in everyone's best interests to have companies that think long-term and manage long-term.

“In other words, sustainable practices and business models are an imperative,” Holland says, adding that he was inspired to write the book to help investors, financial professionals, and students to improve their ability to value a company.

“When evaluating a company, you have to ask whether its board and management team really understand how to create economic value over the long-term. Have they put in place the necessary succession planning, corporate culture, key performance indicators and innovative environment to sustain it? Because if they haven't and if they are focused only on short-term earnings management, then you shouldn't want any part of it unless you are a speculator.”

Beyond Earnings is available at www.amazon.com and www.takealot.com or google book
Source:

University of Cape Town Graduate School of Business
UCT GSB is internationally renowned as one of a few business schools in Africa with the prestigious triple-crown accreditation with endorsements from EQUIS, AACSB and AMBA. As a top school with more than five decades of experience in Africa and other emerging markets, UCT GSB has a responsibility to engage with its socio-political and economic context. Its teaching, learning and research are directed towards addressing the complex and pressing economic and social challenges of our world today. Visit our InfoCentre or website.

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