LIVA offers a useful new way to assess returns on equity capital

The answer could be LIVA: Long-term Investor Value Appropriation (bit.ly/3CqEz3F), a metric developed by Phebo Wibbens and Nicolaj Siggelkow at INSEAD, which is an acronym for Institut Europeen d’Administration des Affaires, a business school, and the Wharton School of the University of Pennsylvania, respectively.

Well known accounting-based measures, such as return on assets (RoA) and return on equity (RoE) assess a company for its short-term performance, and are less potent when making comparisons across an industry, sectors, or indeed while assessing a business for its growth potential. Whereas stock market-based measures such as market capitalization (market cap, for short) and earnings per share (EPS) do reflect growth potential, they do not tell us whether the returns are over and above the company’s cost of capital, i.e., whether the net present value of investment is positive. According to the two aforementioned researchers at Wharton and INSEAD, LIVA achieves all of the above, and more, using historical share-price data.

Simply put, LIVA is the backward-looking net present value of all the investments a firm has made over a period. For instance, the LIVA value of TCS in 2021, from a proprietary database (bit.ly/3CLhjOl), was $109 billion, while its market cap was about $185 billion. What this means is that if all the shares of the Tata Group’s software major were purchased at the time of its public listing in 2004 and sold in 2021 after accounting for any cash received in the form of dividends or share buybacks (including bonuses and stock-splits), one would be richer by $109 billion or over ₹8 trillion in 2021, which is a staggering return by any yardstick.

As a tool, LIVA has many advantages over conventional measures of performance and company valuations. Unlike ratio measures like return on assets (RoA) and on equity (RoE), LIVA provides an economic sense of value created (or destroyed) between any two points in time.

Therefore, LIVA can also be used to assess the economic impact of strategic decisions like mergers and acquisitions, and also business spin-offs. Besides, LIVA is unaffected by the size of the firm under investor assessment, while asset-based measures like RoA tend to disproportionately favour smaller and newer firms.

One of the unique attributes of LIVA is that it provides a meaningful estimate of value destroyed by a company in decline. Thus, rather than wait for a company to go bankrupt and then file for liquidation, LIVA can help assess well in advance whether a company is consistently destroying value and is a prime candidate for liquidation. For instance, Reliance Capital, which is going through insolvency proceedings currently, had positive LIVA until 2007. However, post 2007, it destroyed over $21 billion before going bankrupt.

As a measure, LIVA is also well-suited for making aggregate level stock comparisons. For instance, between 1999 and 2021, when one compares LIVA for all listed companies across countries, the most value was created by US companies at $4,716 billion, with Indian companies in third position at $898 billion, respectively.

Surprisingly, in the same period, the most value was destroyed by Japanese companies, at minus $3,327 billion, followed by UK companies at minus $2,080 billion and Chinese companies at minus $1,127 billion. Thus, LIVA is useful in comparing corporate performance across countries or even industries.

Specific to India, until 2008, the top three value-creating sectors were energy, banks and materials. However, since then, most value has been created by companies in the sectors of software and services, household and personal products, and automobiles and auto components. Among other advantages of LIVA, it can provide important clues to assess the impact of changes in policies and regulations in a particular sector or an industry.

Currently, artificial intelligence (AI) is a trending topic across the world and one company that is creating headlines in the context of being a potential gainer from AI adoption is the US-based chip design firm Nvidia. Its market capitalization crossed $1 trillion on 30 May this year. In terms of LIVA, Nvidia did not figure in the list of the top 50 global companies until 2018. However, by 2021, Nvidia was found to be rising fast and it came to occupy the sixth spot globally.

Clearly, LIVA analysis can provide early indications of emerging market trends and serve investors well.

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Updated: 23 Oct 2023, 09:21 PM IST