Value-based management in the real estate and development sector : financial indicators

MBA, North-West University, Potchefstroom Campus, 2014Wealth creation is the ultimate goal of companies, shareholders and all other stakeholders. From the shareholders' perspective, the financial performance of the company is of vital importance to the return on their investment. They are further tied in to the affairs of the company by virtue of the fact that shareholders own the company, often fund the capital for running it, are the residual claimants and bear all the risk related to the company. Growth of wealth for investors is measured in terms of return on the investment made, which includes capital gains or dividend payout or both. In this context, it is important to consider factors that may influence the share price. Financial indicators used in the assessment of corporate performance should correlate with shareholder‟s growth in wealth. Initially traditional accounting-based ratios, such as return on equity, earnings per share (EPS), earnings before interest and tax and net operating profit after tax were used for evaluating corporate performance. When corporations started to focus on shareholder value as a primary long-term objective, the focus shifted from measurement of financial performance with traditional accounting-based ratios to a more strategic approach which emphasises the identification, measurement and management of key performance indicators. Diverse new metrics were developed, which include value-based management (VBM). VBM is an important tool that links value drivers used by employees and frontline managers all the way up to decisions made by senior management. Although there are significant differences between the different value metrics, all of them are, unlike the traditional accounting performance measures, essentially based on the free cash flow (FCF) approach and take the cost of capital into account (Maditinos et al., 2009:184). The primary objective of this study was to identify the underlying financial indicators that correlate with value created by management of companies and therefore the subsequent share price, which is the indicator of wealth created for shareholders. In the quantitative study the correlation of identified financial indicators with share prices in the real estate and development sector of the Johannesburg Stock Exchange was tested. Multiple regressions were developed for each year in the sample period of 2000 to 2010. Average share price (ASP) and change in average share price (CASP), a proxy of company value, were used as dependent variables. Forty-seven financial indicators were identified as independent variables. Of all the regression models developed for ASP, the variables that occurred most frequently over the sample period were EPS, company free cash flow (FCFC) and economic value added 2 (EVA2), indicating their significance to ASP. Of all the regression models developed for CASP, the variables that occurred most frequently over the sample period were EPS, change in net operating working capital and asset turn-over, indicating their significance to CASP. Historical data was used to test the relevance of EPS, FCFC and EVA2 to ASP. The outcomes showed several distinctive correlations.Master