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Prime Numbers

In this blog series, we provide a refresher on how to interpret the metrics underlying
companies’ performance, resource-allocation decisions, and growth strategies.

Recent Posts

Don’t stress about short-term reactions to an M&A announcement

When a company announces a merger or acquisition, executives hold their breath and hope for a favorable reaction from the market. In general, the market tends to be pessimistic about such deals. So a positive reaction must mean that the deal team struck the right terms, told the right story to investors, and has the right strategies in place to appease regulators and create value from the deal long term—right? Maybe not. Our research shows that the market’s immediate reaction to ...

Rethink performance metrics when inflation is high

When inflation is high and expected to stay there a while, metrics like EBITA and ROIC can be less reliable as indicators of performance. To understand why, look at the relationship among EBITA, ROIC, and a company’s cash flow. Long-term inflation can erode cash flows, which can affect the value of a company. To preserve that value, a company’s free cash flow must keep pace with inflation for a no-growth company. But what happens to EBITA and ROIC at the same time? Depending on the ...

Estimating cost of equity when inflation is high

High inflation and rising (though historically low) interest rates are making it more difficult for executives to estimate the cost of equity as part of their financial planning. In part, that’s because many are heavily weighting the arguments from some academics and bankers that rising interest rates have increased the cost of equity and have been a factor in lower equity valuations since the beginning of 2022. The academics and bankers have likely come to these conclusions because they ...

Markets will be markets: An analysis of long-term returns from the S&P 500

Investors have learned to ride out the highs—and more recently, the lows—of the US stock market. They expect fluctuations, and they react to short-term performance. Many might be surprised to learn, however, that since about 1800, stocks have consistently returned an average of 6.5 to 7.0 percent per year (after inflation).1 Our analysis shows that market returns in the past 25 years are within that historical range (exhibit). In 2001, the market capitalization of the companies ...

Estimating the cost of sub-investment-grade debt

Estimating the value of a company with sub-investment-grade debt (rated BB or below) can be difficult for finance professionals. Using traditional measures, such as yield to maturity (YTM), as a proxy for expected returns on a company’s debt may skew estimates of value, in part because the probability of default is higher for companies rated BB and below. A better bet when estimating the value of a company with uncharacteristically high debt levels is to compare its financial targets or ...

Setting expectations with investors about nontraditional projects

Companies are launching all kinds of “nontraditional” initiatives to digitize products and processes or to address looming environmental, social, and governance (ESG) concerns. In these instances, it’s critical to understand whether companies can achieve and sustain both high returns and low costs of capital in the long run. Finance fundamentals tell us this does not make sense. Consider a company with a cash flow of $100 million, growing at 2 percent in perpetuity, with a 10 ...

Do consensus estimates accurately reflect operating performance?

Executives and investors often use analysts’ consensus estimates and industry multiples to determine the value of companies. Research shows, however, that analysts’ near-term forecasts are often overly optimistic and don’t always correctly reflect operating performance.1 Business leaders and investors need to know what analysts include or exclude in their forward-looking estimates of performance and how those estimates compare with actual results in the past. They should ...