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18 Comment Cormac Lucey The key to growth How do you grow a company’s value? While it might be hard to do, it certainly isn’t complicated. What financial factors cause a company’s share price to rise? This is a profound question that may elicit several different answers. But finance theory concludes that the key to value growth is that a company should generate a return on invested capital (ROIC) in excess of its cost of capital. ROIC is simply the after-tax version of return on capital employed (ROCE). It is calculated using the following formula: ROIC = EBIT x (1 – t) / (debt + equity). Above the line we show operating profit, or EBIT, less tax. Below the line, we measure the total amount of return-seeking capital financing the firm. ROIC is, in my opinion, the key measure of how well a company is rewarding those who fund it. It is an after-tax measure, so it can legitimately be compared to cost of capital (which is also an aftertax measure). It is the relationship between a firm’s ROIC and its cost of capital that determines whether its value grows or not. Suppose a firm invests €10 million in a project with a cost of capital (or minimum expected return required to compensate investors for risk) of 8%. That means we expect annual returns of at least €800,000. But suppose the project generates annual returns of €1.6 million (i.e. ROIC = 16%) and that returns are expected to continue at similar levels into the future. Question: what is the maximum value that an outside investor with a cost of capital of 8% could put on the project? Answer: €20 million, as €20 million x 8% = €1.6 million, which the project is generating in annual returns. The implication is that generating an ROIC that equals twice the project’s cost of capital has led to a doubling in the value of the project. Over the last 30 years, Kerry’s share price has appreciated at a compound annual growth rate of 16.2%. That’s not far below the 18.2% growth rate of Warren Buffett’s Berkshire Hathaway over the same period. Real-life examples Sophisticated companies are well aware that the key to value growth is generating returns well in excess of cost of capital. Consider DCC plc’s stated objective in an investor presentation last November: “To continue to build a growing, sustainable and cash generative business which consistently provides returns on total capital employed significantly ahead of its cost of capital.” That objective is crystal clear and mercifully free of the aspirational cant that clogs up so many such statements at other companies. More to the point, it has been backed up by results. Since DCC was first listed 22 years ago, it has produced total returns for its shareholders (dividends plus capital gains) of 5,924%. That contrasts with returns of just 768% generated by the FT250 index. Look at the Irish food sector. According to brokers, Investec, Kerry Group generated an ROCE of 12.0% in 2015, comfortably ahead of a cost of capital of 7–8%. This has been a consistent pattern over recent years as the company has migrated away from dependence on the commoditised Irish dairy sector towards greater exposure to the more profitable international food ingredients sector. Over the last 30 years, Kerry’s share price has appreciated at a compound annual growth rate of 16.2%. That’s not far below the 18.2% growth rate of Warren Buffett’s Berkshire Hathaway over the same period. Contrast Kerry’s recent record with that of baked products group, Aryzta. According to Investec, its 2016 ROCE was just 3.7%, well below its cost of capital. The consequence of generating returns below cost of capital has been a sharp fall in the company’s value, the highprofile departures of several senior executives and a strategic review of its decision to diversify into frozen food manufacturing by acquiring 50% of Picard. The bottom line The key to making company value grow is generating returns comfortably in excess of cost of capital. It’s that simple. And it’s that hard. CORMAC LUCEY Cormac Lucey FCA is an economic commentator and lecturer at Chartered Accountants Ireland. ACCOUNTANCY IRELAND APRIL 2017
Comment 19 Emotion: the spoiler Annette Clancy People leaders might baulk at the idea of an ‘emotional’ workplace, but emotion is a positive force if channelled properly. We tend to think of organisations as rational places. Places where decisions are made on the basis of external, observable data. Of course, they are partly that. But organisations are also emotional, chaotic, political and anxiety-provoking places: they are both emotional and emotion generating. We rarely return from work extolling the virtues of technical tasks. We are more likely to talk about our feelings in relation to those tasks. Yet, if we are to believe research, emotion is generally identified as inferior to thought and reason in the workplace. This positioning is mirrored in the elevation of some emotions relative to others: the positive emotions signal good; the emotions most of us complain of when we wish to “kick the dog” are bad. At its most pernicious, this hierarchy is transformed into the utilitarian employment of emotion as a vehicle for advancement, recognition and intelligence. Emotion challenges the restrictions of scientific management with its view of organisations as rational enterprises engaged in productive, efficient tasks facilitated by processes, systems and protocols. Emotion as a disruptor of these ideas is relegated to the ‘irrational’ camp, the dark side. Emotion is the spoiler in the orderly world of management as well as its literature. An intolerable exhibition Sigmund Freud described this dilemma in his introduction of psychoanalysis to the English-speaking world at Clark University in 1909. Freud describes a speaker delivering a talk as a noisy heckler in the audience interrupts proceedings. The heckler is evicted from the audience and the guards go so far as to place chairs against the door to ensure that the heckler cannot re-enter. Even though the door is closed, the muffled protest is still audible, “for now he is making an intolerable exhibition of himself outside the room, and his shouting and banging on the door with his fists interfere with my lecture even more than his bad behaviour did before”. The popular delusion What Freud (and many other management scholars since his time) tells us is that the more we try to delude ourselves that reason trumps feeling, the more we will find ourselves confronted with unpredictable behaviour in the workplace that seems to appear from nowhere. Absenteeism, illness, procrastination, resistance and bad behaviour are only some of the ways in which we creatively bring emotion back into the room. Similarly, trying to generate particular ‘positive’ emotions (such as happiness and satisfaction) and negate others (such as anger or disappointment) will backfire as it isn’t possible to only occupy one end of the emotion spectrum. Proponents of ‘positive thinking’ try to persuade us that changing how we think will change how we feel. Unfortunately, telling ourselves that ill-fitting shoes are ‘grand’ will do nothing but create painful blisters and the development of bad feet. The positive workplace ‘industry’ is flourishing right now as we buy into the idea that feeling bad is simply a character flaw, one that is easily remedied by appropriate training, coaching and mentoring. So, is it wrong to feel angry if I am being bullied at work? No. It’s an entirely appropriate response that needs to be heard and addressed. Shutting the door on negative emotion and telling our colleagues to ‘cheer up’ and ‘think positively’ denies the lived experience Emotion challenges the restrictions of scientific management with its view of organisations as rational enterprises engaged in productive, efficient tasks facilitated by processes, systems and protocols. of organisational members as they negotiate workplace relationships and the pressures of organisational performance. A creative intervention Emotion is a sophisticated form of organisational intelligence. Adopting a position of curiosity in relation to the creative ways in which emotion presents itself can offer fascinating insights into how organisations function and what an organisation’s members deem important. However, reducing the bias towards the ‘rational’ work space, and expanding one’s considerations to the full range of emotions, may be the most creative intervention of all. ANNETTE CLANCY Dr Annette Clancy is a lecturer in organisational behaviour at University College Dublin. www.accountancyireland.ie
Page 1 and 2: VOLUME 49 NUMBER 2 APRIL 2017 Diver
Page 3 and 4: Comment 3 President’s comment Apr
Page 5 and 6: Contents 5 Spotlight 30 Pay gap, or
Page 7 and 8: News 7 Enhancing audit quality anch
Page 9 and 10: Est 1887 News 9 UCD and PwC promote
Page 11 and 12: When you fly Aer Lingus, you‘re c
Page 13 and 14: Annual Dinner 13 Gillian Doherty, C
Page 15 and 16: Comment 15 Brian Keegan An uncharit
Page 17: Comment 17 Write it down Des Peelo
Page 21 and 22: Interview 21 Serving the public goo
Page 23 and 24: Retirement Planning... You have lot
Page 25 and 26: Diversity 25 Diversity... is it goo
Page 27 and 28: Diversity 27 fact that diversity an
Page 29 and 30: LONGBOAT ANALYTICS WINNER FINANCIAL
Page 31 and 32: Diversity 31 than half agreed that
Page 33 and 34: Mandatory Electronic Filing is fast
Page 35 and 36: Diversity 35 We’ve heard the soun
Page 37 and 38: Diversity 37 The road to inclusion
Page 39 and 40: Diversity 39 Sponsorships Organisat
Page 41 and 42: Diversity 41 Thoughts on diversity.
Page 43 and 44: Audit 43 insights for stakeholders
Page 45 and 46: TALK TO TOMORROW’S ACCOUNTANTS TO
Page 47 and 48: Financial Reporting 47 financial re
Page 49 and 50: LEADING PROFESSIONAL PUBLISHING
Page 51 and 52: Restructuring Trends 51 The 2016 re
Page 53 and 54: Restructuring Trends 53 insolvency
Page 55 and 56: Audit Quality 55 should be written
Page 57 and 58: Tax 57 BRASS TAX Current developmen
Page 59 and 60: Tax 59 entrepreneurial and favourin
Page 61 and 62: Tax 61 Furthermore there was no rea
Page 63 and 64: Tax 63 Tax deadlines David Fennell
Page 65 and 66: Professional Standards 65 Consent O
Page 67 and 68: Win a two-night stay at Clontarf Ca
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Membership 69 Quigley, Keith Rice,
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Innovation 71 The strategy of innov
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Innovation 73 Graph 1: Title TBD Wh
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Leadership & Management 75 UK acade
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Corporate Governance 77 Figure 1: P
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Leadership & Management 79 Whistlin
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Commercial Feature 81 www.liquidati
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Commercial Feature 83 the high leve
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I trusted my future to Barden So sh
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88 Careers keystrokes and create ju
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90 Careers The hard case for soft s
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92 Careers job can add an entirely
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THE SPECIALIST GOVERNANCE RECRUITME
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EXCELLENCE IN FINANCIAL RECRUITMENT
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98 Member Profile A new orbit From
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NETWORK Building a strong network i
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