Back in the late 1980s, when Tim Koller and his coauthors were looking for publishers interested in a book about business-value creation, they were politely informed that such a book, if successful, would sell perhaps 10,000 copies. Twenty-five years later, Valuation: Measuring and Managing the Value of Companies has not only sold more than 600,000 copies in 11 languages but has also earned a regular spot on business-school curricula and executive bookshelves.
What accounts for Valuation's popularity and longevity? The book, whose sixth edition came out in August, not only explains in simple language how companies create value for shareholders but also links those principles to strategy creation, portfolio management, and capital structure. Less a textbook than a handbook, it uses real-world examples to show how growth and return on capital drive cash flows, which in turn drive value creation.
This practical approach reflects the origins of Valuation as a handbook for McKinsey consultants. When Tim joined the firm in 1987, McKinsey was deepening its corporate finance capabilities to help clients navigate an era of swashbuckling corporate raiders and hostile takeovers. Tim and colleagues produced a guide to advanced valuation techniques contained in a three-ring binder. This became the foundation for the first edition of the book.
Of the three McKinsey authors on the cover of the first edition, only Tim (now a leader in our Strategy & Corporate Finance Practice) remains for the sixth. His coauthors this time around are Marc Goedhardt, a senior expert based in our Amsterdam office; and David Wessels, a finance professor at the Wharton School of the University of Pennsylvania.
Over the years, Tim has seen a number of shifts in the way managers think about value. Historically, managers tended to focus on earnings growth, but return on capital has gradually become just as important for many companies. "That's important because value creation is really about getting the balance right between growth and return on capital," Tim says. "Earnings growth without return on capital does not create value."
The sixth edition arrives at a time of growing concern about corporate short-termism: the all-too-prevalent focus on chasing quarterly earnings growth, even if that puts long-term value at risk. "When I talk to investors, it's clear short-term profits are not what they care about," says Tim. "But while companies will say, 'We are long-term focused,' when you look at their decisions, that doesn't always seem the case." The new edition of Valuation makes a strong case that companies with long-term horizons create more value and outperform competitors.
During client meetings and presentations, Tim often encounters CEOs and CFOs who tell him they read Valuation early in their careers and it changed the way they think about business. He knows that, amidst intense performance pressures and high executive turnover, it takes a lot of courage to do what's needed to build lasting value for the company. His advice: "When executives think about shareholder value creation, nothing says it has to be about today's shareholders. If they think about the collective benefit for today's and future shareholders, they might make different decisions."