Drivers of Shareholder Returns in Tech Industries (or How to Make Sense of Amazon's Market Value) |
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| Authors: | Gregory V. Milano Arshia Chatterjee David Fedigan |
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| Affiliation: | 1. GREGORY V. MILANO is founder and chief executive officer of Fortuna Advisors LLC and is founder, chief executive officer and chief investment officer of Fortuna Investors LLC, a registered investment advisor. Prior to this Greg was managing director and co‐head of the Strategic Finance Group at Credit Suisse and before that he was partner and president of the Americas at Stern Stewart and Co.;2. ARSHIA CHATTERJEE is an associate at Fortuna Advisors LLC. After graduating from Yale University with a Bachelor's degree in Economics, Arshia went on to earn a Master's degree in Finance and Risk Engineering from NYU's Polytechnic (now Tandon) School of Engineering. She worked in the valuation consulting space for two years prior to joining Fortuna.;3. DAVE FEDIGAN is an associate at Fortuna Advisors LLC. Prior to Fortuna Advisors, Dave received his MBA from Georgetown University;4. and before that, he worked at the U.S. Chamber of Commerce in account management and strategy. |
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| Abstract: | Earnings according to GAAP do a notoriously poor job of explaining the current values of the most successful high‐tech companies, which in recent years have experienced remarkable growth in revenues and market capitalizations. But if GAAP earnings fail to account for the values of such companies, are there other measures that do better? The authors address this question in two main ways. They begin by summarizing the findings of their recent study of both the operating and the stock‐market performance of 169 publicly traded tech companies (with market caps of at least $1 billion). The aim of the study was to identify which of the many indicators of corporate operating performance—including growth in revenues, EBITDA margins, and returns on equity—have had the strongest correlation with shareholder returns over a relatively long period of time. The study's main conclusion is that investors appear to be looking for signs of neither growth nor efficiency in using capital alone, but for an optimal mix or balancing of those goals. And that mix, as the study also suggests, is captured in a cash‐flow‐based variant of “residual income” the authors call “residual cash earnings,” or RCE. In the second part of their article, the authors show how and why RCE does a much better job than reported net income or EPS of explaining the current market value of Amazon.com , one of the best‐performing tech companies in the world. Mainly by treating R&D spending as an investment of capital rather than an expense, RCE reveals the value of a company that is distinguished by both the amount and the productivity of its ongoing investment—both of which have been obscured by GAAP. |
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