For What It's Worth

Not everyone who looks at EVA is sold on the concept. Sherry Jarrell, a finance and economics professor at Wake Forest University in Winston-Salem, North Carolina, who specializes in corporate performance measures, says a company that uses EVA may be stifling innovation.

"[EVA] tends to focus managers on the short term and bias companies away from taking the risks they need to take by investing in projects that only pay off over time," Jarrell says. Test-marketing and research and development are two outlays she says EVA has trouble evaluating properly.

While EVA is generally good at estimating value creation, it's only a measuring tool, Jarrell says. "It doesn't help you find value-creating projects," she notes. And Jarrell says that stock-market studies of firms using EVA generally show no correlation between EVA and higher share prices.

Like many business consultants, Stern Stewart advises its EVA clients to toss out other financial performance measures and concentrate only on EVA. Jarrell warns that this may lead to trouble, especially if other crucial measures like cash flow are neglected. "You never want to use just one measure," she says. "You never want to hang the future of the company on one variable."

Despite its limitations, measuring value creation is a good idea for many companies. Mike George, a Dallas investor who buys underperforming companies and uses EVA to turn them around, says businesses that achieve 10 percent revenue growth and returns that beat average capital costs by 5 percent will perform like stars. "If you grow them both," George says, "you can triple the value of your company."

Employing EVA with the help of business consultants isn't cheap. Costs can be trimmed, however, if you do it yourself. You can get most of EVA's benefits by reading a book on the topic and applying the techniques, according to Ehrbar. Fortunately, most firms are already collecting the kind of financial data they'll need to use EVA, and implementing EVA is not a long-term project: Smaller firms should see results in a few months.

This article was originally published in the December 1998 print edition of Entrepreneur with the headline: For What It's Worth.