Value: The Four Cornerstones of Corporate Finance
The four cornerstones
The four cornerstones of finance and value creation are built upon deep and broad McKinsey research and are illuminated in Value with numerous exhibits, examples, and company cases. The cornerstones are:
The core of value
The combination of growth and return on capital, and resulting cash flow, drives value creation. This explains why some companies typically trade at high P/E multiples despite low growth. What's important about this is that where a business stands in terms of growth and return on invested capital (ROIC) can drive significant changes in its strategy. For businesses with high returns on capital, improvements in growth create the most value; for businesses with low returns, improvements in ROIC provide the most value.
The conservation of value
Value is created when companies generate higher cash flows, not by rearranging investors' claims on those cash flows. When a company substitutes debt for equity or issues debt to repurchase shares, for instance, it changes the ownership of claims to its cash flows—but it typically doesn't change the total available cash flows, unless taxes change. Similarly, changing accounting techniques may create the illusion of higher performance without actually changing the cash flows, so it won’t change the value of a company.
The expectations treadmill
A company's performance in the stock market is driven by changes in the stock market’s expectations, not just the company’s actual performance (growth, ROIC, and resulting cash flow). The higher the stock market’s expectations for a company's share price become, the better a company has to perform just to keep up. Although certain companies can deliver unusually high total returns to shareholders for some period of time (usually no more than three years), they eventually hit a wall and disappoint.
The best owner
There is no such number as an inherent value for a business; rather, a business's value is relative to who owns it or might own it. Different owners will generate different cash flows for a business based on the strategies they pursue and their unique abilities to add value. Some, for instance, add value through unique links with other businesses in their portfolios, such as those with strong capabilities for accelerating the commercialization of products formally owned by upstart technology companies.