Accordingly, TSR is closely monitored by shareholders and executives, as well as the media and proxy advisory services. Although there are other methods of incorporating stock price or TSR as an incentive metric see Exhibit 1 , relative TSR is the most common.
However, using TSR falls short of fulfilling one of the basic tenets of an incentive plan: line of sight. Thus, participants will typically be more engaged. This is especially an issue for relative TSR. By contrast, other measures are typically based on internal, absolute performance. Further, performance share payouts are not included in the SCT.
It does not have regard to the financial situation or needs of any reader and must not be relied upon as financial product advice. Investors should consult a range of resources, and if necessary, seek professional advice, before making investment decisions in regard to their objectives, financial and taxation situations and needs because these have not been taken into account.
Any securities or prices used in the examples given are for illustrative purposes only and should not be considered as a recommendation to buy, sell or hold. Past performance is not indicative of future performance. Hamburger Menu Dialog Open. CommBank Search. Dialog start. Search CommBank. Start typing…. Popular searches. What is shareholder return? Free cash flow from a shareholder perspective. This is the difference between earnings and retained earnings sometimes called equity cash flow.
At the company level, it is the portion of earnings paid out to investors. In a year when a company neither issues nor repurchases equity, free cash flow is simply the dividends paid to shareholders. Economic profit. This is the difference between earnings and the cost of invested capital for a given period of time. A business that is earning at least its cost of capital is generating positive economic profit; a business that is earning less than its cost of capital has negative economic profit, even if its earnings are positive.
Warranted value. This is the current value of a company or an operating unit based on the best estimate of its expected free cash flow or economic profits under a particular future strategy. This metric is sometimes called intrinsic value. There are two important points to be understood about warranted value.
First, a company or operating unit has as many warranted values as there are valid alternative strategies for it to pursue. Second, warranted value is not the same thing as market value, nor is warranted value per share the same thing as stock price. Therefore, choose your strategies and make investment decisions based on your warranted value — not on your stock price or, for that matter, any other single financial metric such as revenue growth, return on capital ROC , or earnings per share EPS.
Hence, if your company operates in a way that maximizes long-term warranted value per share over time, it is managing in a way that also maximizes long-term TSR over time.
Likewise, when added to invested capital, the present value of future economic profits will yield exactly the same estimate of warranted value as the present value of free cash flow. Working to maximize economic profit growth over time is thus the same thing as working to maximize long-term value creation and TSR.
In practice, you should not rely on any one measure or criterion to make strategy choices and investment decisions. If you did, the single best measure for such purposes would be warranted value. No other measure can capture the trade-offs between growth and profitability, short term and long term, and risk and reward better than warranted value. But in itself, this metric is inadequate. Do not use warranted value or metrics derived from it, such as total business return for performance management or incentive compensation.
It is based on a forecast of expected future results, not on actual delivered results. Instead, use a combination of three measures — revenue growth, economic profit, and free cash flow — to set business targets, track strategy execution, and evaluate management performance. These three measures capture virtually all the high-level financial information that is important for an operating unit.
As long as internal management reporting processes are designed to report these measures accurately, they provide excellent feedback on whether the value creation expectations of a particular strategy are being met.
Moreover, they are good indicators of which questions to ask and where to look for answers when performance is off track. Managing for top-tier TSR means always choosing the course of action that has more warranted value per share than any other alternative.
When understood and used appropriately, managing for top-tier TSR will produce high-quality, sustained EPS growth and a premium multiple.
In large part, this is because a greater portion of your investment financial resources, management time goes into value-creating activity, and this gives your company more competitive and financial strength.
It also enables you to invest in your future and in building the right capabilities as your markets inevitably evolve.
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