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 Krispy Kreme Doughnuts
Russell 3000 Percentile
|Krispy Kreme Doughnuts||2.2%||5.4%||1.7%||53|
Buffalo Wild Wings
Ruth's Hospitality Group
Source: EVA Dimensions LLC.
With an EVA momentum of 1.7%, Krispy Kreme Doughnuts' economic value added increased year over year, placing it in the 21st percentile of all companies in the Russell 3000. Two of the three remaining companies had positive EVA momentum over the past 12 months. Remarkably, both Krispy Kreme Doughnuts and Buffalo Wild Wings have consistently increased their economic value added over the past three years.
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.
Buffalo Wild Wings is a Motley Fool Hidden Gems selection. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
More from The Motley Fool
Better Buy: Starbucks Corporation vs. Krispy Kreme
Do you need more coffee or doughnuts in your portfolio?
Krispy Kreme Doughnuts and Wayfair Inc. Soar on Flat Day for Stocks
Why these two stocks broke away from broader indexes on Monday to post huge gains.
Why Krispy Kreme Doughnuts, Inc. Stock Skyrocketed Today
The doughnut maker is being acquired in a go-private transaction.