The Ultimate Share Price Driver
- Warren Buffett has made his fortune by focussing on it.
- ABC Learning failed because of it.
- Australian companies don’t get it.
It is a deceptively simple ratio called return on equity. This ratio measures the returns generated by the management team from the equity entrusted to them by shareholders.
Every CEO should be across this ratio. It is the single most important share price driver.
Not earnings growth as many analysts would have you believe.
Twelve years ago the market was fooled into believing ABC Learning was an excellent investment with its reported Net Profit after Tax having risen from $12m in 2003 to $143m in 2007. Outstanding!
What this masked was the fact that ROE had fallen to a miserable 5% in 2006. In other words, earnings growth was only achieved because unsuspecting shareholders (and banks) kept shovelling money in to the company. But that incremental equity wasn’t matched by an increased ROE.
Some time ago, Phil Ruthven was troubled by the fact that the average for Australia’s top 1000 companies makes 8 per cent return on equity.
Most astute investors, including Phil, will filter you out unless you hit a 20 per cent return.
Of course talking about ROE is one thing, doing something concrete about it is another.
If you are a data-driven company you are in good shape for what follows. If not, you will have a bit more work to do to get everyone on board with this ROE Program.
Here are some ideas. Ideas to get everyone focussed on ROE – top to bottom in your company:
We introduce a multi-faceted approach. One that maximizes your chance of success. We approach it from a few different angles. Single approaches such as training in what ROE means rarely works on its own.
- Visually make the link from ROE to what happens on the ground. For instance connect Process Time in the factory right through to ROE in the boardroom. This can be done with Value Driver Trees.
- Delegate accountability per node to one owner in your Value Driver Tree. When two or more people are accountable for a performance measure, no one is accountable.
- Each node is to have a target. The node owner needs to be fully involved in the target setting process.
- Leadership by example is critical. You and your leadership team need to live and breathe ROE. Participate actively in problem solving sessions (see next point).
- Key to the success of your “ROE Program” is solving problems and implementing ideas. Make sure time is allowed/encouraged for people to innovate. Time that is above and beyond their current busy schedules. Allow time for people to THINK!
- Recognise everyone’s contribution to ROE, including the young analyst in Finance who loads the data. She needs to be recognised for her important contribution. Data needs to be always fresh and up to date.
- Ensure data is refreshed regular and timely.
- Train everyone in a full understanding of how ROE works, including the process of solving problems and implementing improvement ideas and evaluating the results of these ideas.
- Encourage teams to help each other.
- Make sure the environment is conducive to creativity – meeting rooms for instance with large TV screens, think about colours and décor conducive to creativity, decluttered work areas are very important too.
- Thread ROE into your formal rewards & recognition program and even individual’s job descriptions.
- Performance to target is recognised. Underperformance is addressed with coaching and other forms of assistance. Continued underperformance is confronted with honesty.
If you would like to discuss how a ROE Project like this may apply to your business, drop me a note.