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Managing Expectations For Value
A higher market capitalization is now an important corporate objective, both to drive perceptions of economic success and to help companies achieve their strategic goals. As a metric for corporate performance, market capitalization reflects both current performance and future expectations. If you split the average market capitalization of the Eurostoxx50 into the perpetuity value of current earnings per share1 (the value of current performance) and residual value2 (the value of growth expectations), an interesting trend becomes apparent: the proportion of the average Eurostoxx50 company's market capitalization that is tied to market expectations of growth soared from 26 percent in 1995 to 70 percent in 1999. This suggests that building long-term growth expectations is more and more relevant for active value management—a reality that many companies haven't yet begun to address systematically.
Traditional corporate-performance metrics, such as price-to-earnings ratios, market-to-book ratios, and market value added, don't explicitly reflect the importance of growth expectations. As a result, companies often pursue value-management approaches that neglect opportunities for growth, sometimes even risking the companies' long-term survival.
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