Warren Buffett's partner, Charlie Munger, once said, "I think I've been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther."

When corporate boards use bad incentivesfor management's pay, disaster often ensues.(Think Lehman Brothers.) Incentives based on singular metrics such as revenue growth, EBITDA, ROE, or earning per share are easily manipulated and gamed. Fortunately, there is a better way: EVA momentum.

Creator Bennett Stewart of EVA Dimensions, who also co-created EVA (economic value added), calls EVA momentum "the only percent metric where more is always better than less. It always increases when managers do things that make economic sense."

So what does this mean for investors? A positive reading on EVA momentum means a company has created value by increasing its EVA, a negative EVA momentum means that EVA and thus value have decreased. EVA momentum is one of the few, if not the only, performance measure with such a clear dividing line between good and bad performance.

The best companies, then, create value in excess of their cost of capital, as reflected by positive EVA momentum. The higher the EVA momentum, the more value management's creating.

Let's look at MedcoHealth Solutions (NYSE: MHS) and three of its wholesale drugs industry peers to see how effectively they create value. Here are the trailing four quarters' worth of EVA momentum figures for each company over the past three years, and rankings versus the Russell 3000 for the past 12 months' EVA momentum.

Company

2008*

2009*

2010*

Russell 3000 Percentile

MedcoHealth Solutions 0.2% 0.5% 0.3% 39
Cardinal Health (NYSE: CAH) 0.0% (0.3%) 0.3% 39
Express Scripts (Nasdaq: ESRX) 0.9% 0.7% 0.6% 42
McKesson (NYSE: MCK) 0.0% 0.2% 0.1% 37


Source: EVA Dimensions LLC. *Trailing four quarters as of third quarter of year indicated.

With an EVA momentum of 0.3%, MedcoHealth Solutions' economic value added increased year over year, placing it in the 39rd percentile of all companies in the Russell 3000. In fact, all four of these companies had positive EVA momentum over the past 12 months. MedcoHealth Solutions and Express Scripts both had consistently increasing value added over the past three years. Hopefully, all of these firms will continue growing their economic value added in the future.

Businesses with high EVA momentum are effectively creating value. It will be interesting to see how useful this extremely new metric proves for companies and investors. If it lives up to its promise, EVA momentum will be an essential tool in investors' arsenals.

Another tool for better investing
Most investors don't keep tabs on their companies' fundamental value. That's a mistake. If you take the time to read past the headlines and crack a filing now and then, you're in a much better position to spot potential trouble early. Better yet, you'll improve your odds of finding the underappreciated home-run stocks that provide the market's best returns.

We can help you keep tabs on your companies with My Watchlist, our free, personalized stock tracking service.

Dan Dzombak's musings and articles he finds interesting can be found on his Twitter account: @DanDzombak. He does not hold any of the stocks mentioned in this article. McKesson is a Motley Fool Inside Value recommendation. McKesson and MedcoHealth Solutions are Motley Fool Stock Advisor choices.

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