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Walter Energy's Management Is Creating Value

By Dan Dzombak - Updated Apr 6, 2017 at 9:37PM

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What EVA momentum shows us about the folks running Walter Energy.

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 incentives for 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 EVA momentum reading means a company has created more value by increasing its EVA while a negative EVA momentum reading means EVA has decreased, signaling less value creation. EVA momentum is one of the few, if not the only, performance measures 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 faster management is creating value.

Let's look at Walter Energy (NYSE: WLT) and three of its 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 by percentile versus the Russell 3000 for the past 12 months' EVA momentum.

Related Companies

2009 Q1 TFQ

2010 Q1 TFQ

2011 Q1 TFQ

Russell 3000 Percentile

Walter Energy 9.9% (4.1%) 29.7% 95
Arch Coal (NYSE: ACI) 2.0% (5.1%) 4.6% 77
Peabody Energy (NYSE: BTU) 10.6% (4.8%) 5.3% 78
Patriot Coal (NYSE: PCX) 8.3% (2.6%) (3.5%) 18

Source: EVA Dimensions LLC. TFQ = trailing four quarters.

With an EVA momentum of 29.7%, Walter Energy's economic value added increased year over year, placing it in the 95th percentile of all companies in the Russell 3000. Two of the three remaining companies also had positive EVA momentum over the past 12 months.

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.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Walter Energy, Inc. Stock Quote
Walter Energy, Inc.
WLTGQ
Peabody Energy Corporation Stock Quote
Peabody Energy Corporation
BTU

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