Companies create value by investing capital at rates of return that exceed their cost of capital. At times, the stock market may not be a reliable indicator of a company's intrinsic value.
Paradoxically, the fact that markets can deviate from intrinsic values means that managers have to be more attuned to the underlying value of their businesses and how their companies go about creating value, because they can't always rely on signals from the stock market.
Specifically, managers must not only have a theoretical understanding of value creation, but must be able to create tangible links between their strategies and value creation.
This means, for example, focusing less on recent financial performance and more on what they are doing to create a “healthy” company that can create value over the longer term. It means having a thorough grounding in the economics of an industry and setting aspirations accordingly.
Once they've mastered the economics of value creation, they need to be able to educate their internal and external constituents.
They need to install performance management systems that encourage real value creation, not merely short-term accounting results. Finally, they need to educate their investors about how and when the company will create value.
These principles apply equally to mature manufacturing companies and highgrowth technology companies. They apply to companies in all geographies. When managers, boards of directors, and investors forget these simple truths, the consequences can be destructive.
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