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The Next FrontierBui ld ing an In teg ra ted S t ra tegy fo r Va lue Crea t ion

THE 2004 VALUE CREATORS REPORT

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Back to Fundamentals: Value Creators Report 2003

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The Next Frontier

Bui ld ing an In teg ra ted S t ra tegy fo r Va lue Crea t ion


ERIC OLSEN

DANIEL STELTER

PASCAL XHONNEUX

D E C E M B E R 2 0 0 4

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© The Boston Consulting Group, Inc. 2004. All rights reserved.

For information or permission to reprint, please contact BCG at:E-mail: [email protected]: +1 617 973 1339, attention BCG/PermissionsMail: BCG/Permissions

The Boston Consulting Group, Inc.Exchange PlaceBoston, MA 02109USA

2 BCG REPORT

3The Next Frontier

Table of Contents

About this Report 4

For Further Contact 5

Executive Summary 6

Sidebar: The Value Creators Series 7

Lessons of the Top Performers 8

Sidebar: The Components of Total Shareholder Return 9

Sidebar: Two Approaches to Analyzing TSR 16

The Case for an Integrated Value-Creation Strategy 19

Sidebar: The Value-Creation Challenge 20

Improving Fundamental Value 23

Exploiting Valuation Multiples 29

Sidebar: Expectation Premiums and Comparative Multiple Analysis 32

Sidebar: Engineering a Soft Landing 34

Prioritizing the Uses of Free Cash Flow 37

Sidebar: Share Buybacks Versus Dividends 40

Sidebar: Using Free Cash Flow to Improve the Valuation Multiple 41

Five Steps for Building an Integrated Value-Creation Strategy 42

Sidebar: Questions Every CEO Should Know How to Answer 43

Methodology 45

The 2004 Global Rankings 46

The 2004 Regional Rankings 52

The 2004 Industry Rankings 61

This research report is a product of the Corporate Finance and Strategy practice of The Boston ConsultingGroup. Eric Olsen is a senior vice president and director in BCG’s Chicago office and global leader of thefirm’s Value Management topic area. Daniel Stelter is a senior vice president and director in BCG’s Berlinoffice and global leader of the firm’s Corporate Finance and Strategy practice. Pascal Xhonneux is a vicepresident and director in the firm’s Düsseldorf office and leader of the Value Creators research team.

AcknowledgmentsThe authors would like to acknowledge the contributions of BCG’s global experts in corporate finance andstrategy:

Kees Cools, executive adviser in BCG’s Amsterdam office and global leader of research and marketing forthe firm’s Corporate Finance and Strategy practice

Gerry Hansell, vice president and director in BCG’s Chicago office and leader of the firm’s CorporateFinance and Strategy practice in the Americas

David Pitman, vice president and director in BCG’s Sydney office and leader of the firm’s Corporate Financeand Strategy practice in Asia-Pacific

Frank Plaschke, manager in BCG’s Munich office and project leader of the Value Creators research team

Brett Schiedermayer, vice president at the BCG ValueScience Center in Mountain View, California, a jointventure of BCG and ValueScience Corporation that develops leading-edge valuation tools and techniques forM&A and corporate strategy applications

The authors would also like to thank Martin Link and Kerstin Biernath of BCG’s Munich-based ValueCreators research team.

To Contact the AuthorsThe authors welcome your questions and feedback.

About this Report

4 BCG REPORT

Eric Olsen The Boston Consulting Group, Inc.200 South Wacker DriveChicago, IL 60606USATelephone: +1 312 993 3300E-mail: [email protected]

Daniel Stelter The Boston Consulting Group GmbHDircksenstrasse 4110178 BerlinGermanyTelephone: +49 30 28 87 10E-mail: [email protected]

Pascal Xhonneux The Boston Consulting Group GmbHStadttor 140219 DüsseldorfGermanyTelephone: +49 211 30 11 30E-mail: [email protected]

5

For Further Contact

The Next Frontier

The Corporate Finance and Strategy practice of The Boston Consulting Group is a global network of expertshelping clients design, implement, and maintain superior strategies for long-term value creation. The prac-tice works in close cooperation with BCG’s industry experts and employs a variety of state-of-the-art method-ologies in portfolio management, value management, mergers and acquisitions, and postmerger integration.For further information, please contact the individuals listed below.

The Americas

Alan WiseBCG Atlanta+1 404 877 [email protected]

Gerry HansellBCG Chicago+1 312 993 [email protected]

J PuckettBCG Dallas+1 214 849 [email protected]

Balu BalagopalBCG Houston+1 713 286 [email protected]

Thomas WenrichBCG Mexico City +52 55 5258 [email protected]

Jeffrey KotzenBCG New York+1 212 446 [email protected]

Miki TsusakaBCG New York+1 212 446 [email protected]

Rohit BhagatBCG San Francisco+1 415 732 [email protected]

Walter PiacsekBCG São Paulo+55 11 3046 [email protected]

John BogertBCG Toronto+1 416 955 [email protected]

Robert Hutchinson BCG Washington+1 301 664 [email protected]

Europe

Kees Cools BCG Amsterdam+31 35 548 [email protected]

Yvan JansenBCG Brussels+32 2 289 02 [email protected]

Lars TerneyBCG Copenhagen+45 77 32 34 [email protected]

Stuart KingBCG London+44 20 7753 [email protected]

Juan GonzálezBCG Madrid+34 91 520 61 [email protected]

Thomas LewisBCG Milan+39 0265 [email protected]

Stephan DertnigBCG Moscow+7 095 258 [email protected]

Victor AerniBCG Zürich+41 1 388 86 [email protected]

Asia-Pacific

Herbert HsuBCG Hong Kong+852 2506 [email protected]

Andrew ClarkBCG Jakarta+62 21 526 [email protected]

Nicholas GlenningBCG Melbourne+61 3 9656 [email protected]

Anurag PoddarBCG Mumbai+91 22 2283 [email protected]

Byung Nam RheeBCG Seoul+822 399 [email protected]

Roman ScottBCG Singapore+65 6429 [email protected]

David PitmanBCG Sydney+61 2 9323 [email protected]

Naoki ShigetakeBCG Tokyo+81 3 5211 [email protected]

Executive Summary

6 REPORTBCG 6

its underlying fundamental value) continue to bea major drag on world capital markets. Afterreaching unprecedented heights in 2000, globalexpectation premiums are fast approaching zero.

• At the same time that average expectation premi-ums have declined, the premiums of the top-per-forming companies have increased. The growingdivergence in expectation premiums between aver-age companies and the best reflects the above-aver-age improvements in fundamental value of the topperformers as well as the increasing discernmentof investors in today’s stock pickers’ market.

• The decline in expectation premiums in high-growth industries such as technology and phar-maceuticals means that traditional old-economyindustries are the best performers on average.For example, the pulp-and-paper sector postedthe highest five-year average annual TSR of the 12industries in our global sample: 9 percent.

• Distributions of free cash flow, in the form of debtrepayment and dividends, are becoming a moreimportant component of TSR for many compa-nies. BCG surveys of more than 100 institutionalinvestors suggest that they value such direct dis-tributions more highly than in the past.

• Looking to the future, average annual TSR islikely to be somewhere between the abnormallyhigh returns of the 1980s and 1990s (averagingabout 16 percent) and the negative returns of thepast five years. If market analysts are right, annualTSR will probably average between 7 and 9 per-cent over the next decade—slightly below thelong-term average of 10 percent.

To succeed in a market characterized by more dis-cerning investors and more modest returns, seniorexecutives will need to make sure they are takingadvantage of the full range of levers available fordelivering TSR. And they must develop a moredynamic and multifaceted approach to value cre-ation than they have typically taken in the past. Wecall this approach an integrated value-creation strategy.It has three main components:

After 2003’s double-digit returns, average totalshareholder return (TSR) to date in 2004 is barelyabove zero. Companies across the world are experi-encing a stock pickers’ market, where returns are afunction more of a company’s individual perform-ance than of across-the-board industry or macroeco-nomic trends. Creating value in such an environ-ment poses tough challenges for senior executives,but in one respect, the new focus on individual com-pany performance also represents an importantopportunity. The ability of executives to shape theircompany’s value-creation performance lies squarelyin their own hands. More than ever, investors placea premium on good long-term management.

The Next Frontier: Building an Integrated Strategy forValue Creation, the sixth annual report in the ValueCreators series published by The Boston ConsultingGroup, puts these challenges and opportunities in abroader context. (For more information on theValue Creators reports, see the sidebar on page 7.)In these pages, we analyze the five-year market per-formance of nearly 600 global companies across 12industries. We look behind the stock-market resultsto identify the sources of superior performance,and we propose key areas of focus for companies todeliver superior TSR in the future. Among the high-lights of this year’s study:

• Despite last year’s strong returns, global capitalmarkets have still not recouped the value lost inthe steep decline since their 2000 peak. Accord-ing to the Morgan Stanley Capital International(MSCI) World Index, five-year average annualTSR for the period from 1999 through 2003 wasan anemic –0.9 percent.

• Global financial markets are continuing the “backto fundamentals” trend identified in last year’sstudy.1 The underlying economic value of the 596companies in our global sample improved by 11 percent between 1999 and 2003, that of thetop decile by 20 percent, and that of the globaltop ten companies by 28 percent.

• However, declining expectation premiums (thedifference between a company’s market value and

1. See Back to Fundamentals, BCG Value Creators report, December 2003.

The Next Frontier 7

• Revisiting Priorities for Using Free Cash Flow. One ofthe most important strategic decisions senior ex-ecutives face is what to do with the free cash flowtheir company generates. To what degree shouldthey invest it internally, use it to fund acquisitions,or return it to investors either by paying downdebt, paying out dividends, or buying back shares?In a stock market where expected returns aremodest and direct distributions of free cash floware becoming a more important component ofthe total TSR package, companies need to revisittheir priorities for the use of free cash flow.

This year’s Value Creators report addresses the chal-lenges and the benefits of creating a truly integratedvalue-creation strategy. In the pages that follow, we

• report on the rankings of the top-performers andanalyze the sources of their success

• describe the key components of an integratedvalue-creation strategy and how it changes theway executives think about value management

• introduce new analytical techniques that execu-tives can use to manage tradeoffs across the keydrivers of value creation

• describe five steps for creating and managing anintegrated value-creation strategy

• Improving Fundamental Value. Long the focus oftraditional value management, improving funda-mental value remains at the core of an integratedvalue-creation strategy. And of all the factors con-tributing to fundamental value, by far the mostimportant over the long term is profitablegrowth. BCG estimates that from two-thirds tothree-fourths of a company’s TSR over the longterm is due to profitable growth. This is a timelyobservation, because after a period of cost cuttingand belt-tightening, many executive teams nowface the challenge of rebuilding their company’sgrowth engine.

• Exploiting Valuation Multiples. But companies alsoneed to supplement their traditional long-termfocus on fundamental value with a more sophisti-cated understanding of how external capital mar-kets value a company in the short to mediumterm. Investor expectations—as reflected in acompany’s valuation multiple relative to that of itsindustry peers—can be an important enabler of,or constraint on, a company’s value-creation strat-egy. In this year’s report, BCG introduces a newmethodology that allows executives to identifyempirically the drivers of valuation multiples intheir industry; anticipate the impact of manage-ment actions on a company’s multiple; and,within limits, manage the multiple over time.

The Next Frontier is the sixth annual report in theValue Creators series published by The BostonConsulting Group. Each year, we publish detailedempirical rankings on the stock-market performanceof the world’s top performers and distill manageriallessons from their success. We also highlight keytrends in the global economy and world capital mar-kets and describe how these trends are likely toshape future priorities for value creation. Finally, weintroduce new or improved analytical tools devel-oped by BCG for managing value creation.

Our past reports have consistently emphasized thecentral importance of improvements in fundamentalvalue in long-term value creation. At the same time,we have introduced new perspectives over the yearsthat go beyond traditional value management inorder to develop insights on a range of issues such

T H E V A L U E C R E A T O R S S E R I E S

as the role of investor expectations, investor strategy,and dividend policy.

This year, we combine insights from past reports withnew thinking and analytical tools to present an inte-grated value-creation model, one that emphasizes theall-important linkages across a company’s fundamen-tal-value engine, its valuation multiple in the market,and its financial policies such as dividend payout andcapital structure. We think this integrated approach isa distinct improvement on existing approaches to valuemanagement because it focuses managerial attentionon the tradeoffs that executives must manage in whatis a highly dynamic value-creation system. We alsobelieve that this integrated approach holds lessons forall managers—irrespective of industry and startingposition and of whether or not their companies cur-rently happen to be top performers.

Lessons of the Top Performers

8 BCG REPORT

In the six years that we have been conducting theBCG Value Creators study, global capital marketshave gone through a period of extraordinary volatil-ity. Our first report in 1999 catalogued how long-termeconomic growth and unusually low costs of capital(due mainly to low interest rates) had led to a longboom in market values during the 1980s and 1990s.2

Subsequent studies tracked the development, andwarned of the ultimate decline, of a financial bubblein which inflated investor expectations pushed mar-ket values to unsustainable heights.3 More recently,we have analyzed how companies have struggled withthe combined impact of this deflation in market val-ues and the post-9/11 recession, primarily by refocus-ing on improving fundamentals through cost cuttingand operational improvement.4

This year’s rankings reflect the continuing volatilityof world capital markets. According to the MSCIWorld Index, global total shareholder return (TSR)averaged 25.5 percent in 2003—the first positiveannual return since 1999. (For a detailed description

of TSR, see the sidebar “The Components of TotalShareholder Return.”) In 2004, however, TSR aver-aged only 4.1 percent through mid-October. Andover the five-year period from 1999 through 2003(the time period we will use in this study), averageTSR was actually a negative 0.9 percent per year. Inother words, global capital markets have still notrecouped the massive amount of value destroyed inthe years after their 2000 peak.

What kind of improvement in TSR was necessary toachieve top-quartile status, given those market aver-ages? Exhibit 1 arrays the 596 companies in our

2. See The Value Creators: A Study of the World’s Top Performers, BCG ValueCreators report, September 1999.

3. See New Perspectives on Value Creation, BCG Value Creators report,November 2000; and Dealing with Investors’ Expectations: A Global Studyof Company Valuations and Their Strategic Implications, BCG ValueCreators report, November 2001.

4. See Succeed in Uncertain Times: A Global Study of How Today’s TopCorporations Can Generate Value Tomorrow, BCG Value Creators report,November 2002; and Back to Fundamentals, BCG Value Creators report,December 2003.

E X H I B I T 1

AVERAGE ANNUAL TOTAL SHAREHOLDER RETURN BY QUARTILE, 1999–2003

SOURCES: Thomson Financial Datastream; BCG analysis.

NOTE: TSR derived from calendar year data; values shown for top ten companies only.

0

100

200

300

400

500

–60 –40 –20 0 20 40 60 80 100 120

Average annual TSR (%)

First quartile

Second quartile

Third quartile

Fourth quartile

n = 596

20.4

9.0

2.1

–6.8

Number of companies

Medianaverage annual

TSR (%)

9The Next Frontier

The most comprehensive measure of value creationis total shareholder return (TSR). TSR measures thechange in a company’s market value, plus its divi-dend yield (including changes in the number ofshares), over a given period of time. There are threebasic ways to increase it.

• By improving fundamental value. Fundamentalvalue represents the discounted value of the futurecash flows of a business, based on its margins,asset productivity, growth, and cost of capital.

• By increasing investor expectations. A companycan grow its share price by improving how the mar-ket values the company’s fundamental performanceat a given moment. Investor expectations are meas-ured by a company’s expectation premium and canbe further analyzed by comparing a company’s val-uation multiple to that of its industry peers.

• By optimizing distributions of free cash flow. Acompany can also improve TSR by distributingcash to investors. For example, dividends contributedirectly to TSR. But dividends, share repurchases,and debt payments can also contribute indirectly byaffecting a company’s valuation multiple.

Fundamental value, investor expectations, and freecash flow are integral parts of a dynamic value-cre-

T H E C O M P O N E N T S O F T O T A L S H A R E H O L D E R R E T U R N

ation system. Changes in any one area can haveimpacts on the others. The basic challenge of valuecreation is to understand the linkages among thesethree components and manage the tradeoffs acrossthem to ensure that management actions are mutu-ally reinforcing rather than contradictory.

THE DRIVERS OF TOTAL SHAREHOLDER RETURN

SOURCE: BCG analysis.

TSR

Capital gain

Free-cash-flow yield

Fundamental value

Investor expectations

Share buybacks

Debt repayment

Dividend yield

5. See William J. Bernstein, “The Returns Fairy . . . Explained,”www.efficientfrontier.com, Spring 2003; E.S. Browning, “Point/Counterpoint—Pull Up a Chair for a Debate: A Bull and a Bear Fight ItOut over Stocks, Oil, Bush/Kerry,” Wall Street Journal, August 2, 2004;Curt Morrison, “Stock Market Returns Are Likely to Disappoint,”www.morningstar.com, August 11, 2004; “Economic Focus—RealisticRewards,” The Economist, August 21, 2004, p. 64; and JonathanClements, “Waiting for Stocks to Get Cheap Again? Relax—It CouldTake Four More Years,” Wall Street Journal, September 1, 2004.

12-industry global sample according to their five-yearTSR performance. (For a discussion of the companysamples used in this study, see “Methodology,” page45.) As a group, these companies beat the MSCIWorld Index average, but only slightly—theirweighted average annual five-year TSR was 0 percent.In order to achieve top-quartile status, companiesneeded to post an average annual TSR of at least 13.3 percent. The very best performers had returnsof 50 percent and higher.

Looking to the immediate future, it seems likely thataverage returns will increase from those of the pastfive years, but markets are unlikely to return to theapproximately 16 percent average annual TSRs ofthe 1990s. Consider the example of the U.S. market.Over the very long term, the U.S. S&P 500 has gen-erated average annual returns in the neighborhoodof 10 percent. But a BCG review of market forecasts

shows that most estimates for the coming decadecluster in the neighborhood of 7 to 9 percent. Andsome more pessimistic scenarios see returns drop-ping below 5 percent per year.5

The Revenge of the Old Economy? When we seg-ment company performance by industry, a strikingfinding emerges. Exhibit 2, page 10, ranks the 12industries in our study by five-year annual averageTSR. The upper table orders the industries by sam-ple average, the lower according to the average per-

formance of their top ten companies. The most suc-cessful industries, on average, are traditional old-economy sectors such as pulp and paper, industrialgoods, and chemicals. When the sample is restrictedto the top performers in each industry, growth sec-tors such as technology and pharmaceuticals andbiotech move into the top ranks. But more tradi-tional sectors like industrial goods, automotive, andpulp and paper are three of the top five.

The Continuing Decline in Investor Expectations.There is a simple but powerful reason for what mightbe described as the revenge of the old economy: thecontinuing deflation of the late-1990s financial bub-ble as investors radically revise their expectations forhigh-growth sectors of the economy. Exhibit 3depicts the long-term evolution of expectation pre-miums for selected companies of the U.S. S&P 400between 1926 and October 2004. A company’sexpectation premium is the difference between itsactual market value and the value derived from ananalysis of its underlying fundamentals.6

Two trends are worth noting. After reaching un-precedented highs in 2000, average expectation pre-miums have been dropping consistently to the pointwhere fundamental values now account for the fullmarket value of these companies. This decline inaverage expectation premiums has hit previouslyhigh-flying sectors like technology particularly hardand accounts for the fact that the long-term marketperformance of many old-economy industries looksmuch better than it did a few years ago.

What’s more, as the historical trend in Exhibit 3shows, when expectation premiums decline, they tendto overshoot, eventually moving below zero. In otherwords, declining investor expectations push marketvalues below underlying fundamental values. A con-tinuing decline may well justify the more pessimisticestimates of future TSR below 5 percent per year.

The Growing Divergence of Expectations BetweenAverage and Top Performers. Does this decline ininvestor expectations confirm the movement“back to fundamentals” that we identified in our2003 Value Creators report?7 In one importantrespect, yes. Exhibit 4 compares the trend in fun-

10 BCG REPORT

E X H I B I T 2

AVERAGE ANNUAL TOTAL SHAREHOLDER RETURN BY INDUSTRY, 1999–2003

SOURCES: Thomson Financial Worldscope; Thomson Financial Datastream;

Bloomberg; Annual Reports; BCG analysis.

1Weighted average of respective sample.

Industrial goods

Technology

Automotive and supply

Utilities

Pharmaceuticals and biotech

Pulp and paper

Chemicals

Travel, transport, and tourism

Retail

Consumer goods

Multibusiness

Media and entertainment

13

22

25

27

30

31

36

21

20

16

14

20

–3

2

3

3

6

8

9

2

0

0

–2

1

Pulp and paper

Industrial goods

Chemicals

Technology

Multibusiness

Travel, transport, and tourism

Consumer goods

Automotive and supply

Retail

Utilities

Pharmaceuticals and biotech

Media and entertainment

TSR (%)

TSR (%)

Total sample1

Top ten performers

6. For a detailed discussion of expectation premiums, see “ExploitingValuation Multiples,” p. 29.

7. See Back to Fundamentals, BCG Value Creators report, December 2003.

11The Next Frontier

E X H I B I T 3

EVOLUTION OF EXPECTATION PREMIUMS AT SELECTED U.S . S&P 400 COMPANIES, 1926–2004

SOURCES: Moody’s Manual of Investments; Compustat; ValueLine; BCG analysis.

NOTE: 1926–1949, n = 40; 1950–2004, n = 376.

Market high

Market lowMarket average

1926 1935 1945 1950 1965 1970 1975 1980 1985 1995 2000199019401930 1955 1960 Oct. 132004

268

210

0

20

40

60

80

100

120

140

160

180

200

Market value/Fundamental value (%)

E X H I B I T 4

GROWTH IN FUNDAMENTAL VALUE AND EXPECTATION PREMIUMS, 1999–2003

SOURCES: Thomson Financial Datastream; Thomson Financial Worldscope; Bloomberg; BCG analysis.

1Market capitalization plus net debt, 1998 = 100.

2Market values as of October 13, 2004; fundamental value estimated using trailing 12-month average data.

Total global sample Top decile Global top ten

n = 596 n = 60 n = 10

’98 ’03 ’042 ’98 ’03 ’042 ’03 ’042

Value index1 Value index1 Value index1

0

100

200

300

400

500

600

0

100

200

300

400

500

600

’980

100

200

300

400

500

600

100118 119

43%

57%80%

20%

81%

19%–11%/year

11%/year

36%/year

20%/year100

299 319

75%

25% 62%

38%

62%

38%

92%/year

28%/year

100

544

637

57%

43%

91%

9% 51%

49%

Expectation premium Fundamental value

damental values and expectation premiums forthree groups: the 596 companies in our 12-indus-try global sample, the 60 companies in the top-per-forming decile of this sample, and the top tenglobal performers. The exhibit shows thatimprovements in fundamental value took placeacross the three groups and are a key differentia-tor of performance among them. On average, thetotal sample increased fundamental value by 11percent per year between 1998 and 2003, the topdecile by 20 percent, and the global top ten by 28 percent.

However, when one compares the trends in expecta-tion premiums for these three groups, a more com-plex—and more interesting—story emerges. Even asexpectation premiums have been falling on average,the divergence between average expectation premi-ums and those of the top performers has actuallybeen growing. Premiums for the sample as a wholehave actually decreased at a rate of 11 percent per year,and the percentage of overall market value attributa-ble to investor expectations has declined from 43 percent to 20 percent. (So far, this trend has con-tinued in 2004; as of October 13, expectation premi-ums for the entire sample accounted for 19 percentof total market value.)8

For the top performers, however, expectation pre-miums have been growing. For example, the top-decile companies grew their expectation premiumsby 36 percent, on average. In 1998, expectationsaccounted for 25 percent of total company value,and by 2003, they accounted for 38 percent, a ratiothat has continued in 2004.

For the global top ten, the increase in expectationpremiums is even more dramatic. For this group ofthe very best performers, average expectationpremiums grew a whopping 92 percent. In 1998,they accounted for only 9 percent of the total mar-ket value of this group; by 2003, they accounted for43 percent. Both the absolute value of these topperformers’ premiums and their percentage oftotal market value have continued to increase in2004. Some of this increase can be attributed to acyclical rebound from these companies’ below-aver-

age starting point, but the rest is due to increasedexpectations consistent with their above-averageimprovements in fundamental value.

Put another way, the top performers continue tobenefit from substantial expectation premiums,despite the fact that average premiums for thesample as a whole have declined substantially.This growing divergence between the best and therest reflects both the above-average improvementin the fundamentals of these companies and theincreasing discernment of investors in the currentstock pickers’ market environment. The challengefor top performers in the years ahead, of course,will be to continue to live up to the high expecta-tions currently embedded in their stock pricesand to make sure that future expectations do notoutpace the ability of these companies to deliver.

The divergence in expectation premiums is consis-tent across most of the industries we have analyzedfor this year’s Value Creators report. In 7 out of the12 industries studied, the absolute values of expecta-tion premiums have declined on average butincreased for the top ten industry performers. In anadditional 3 industries, the absolute values of expec-tation premiums are growing on average, but grow-ing much faster for the top ten. (For a detailed analy-sis of trends by industry, see “The 2004 IndustryRankings” on page 61.) These results suggest thatthe range of premiums in many industries is gettingbroader. In such an environment, it is important forcompanies to learn to identify the drivers of theirpremiums, relative to industry peers, and to under-stand the consequences for their value-creationstrategies.

Determining the Sources of TSR. To dig deeperinto the sources of the top performers’ success,BCG has developed an approach that breaks downa company’s TSR into six financial metrics com-monly used by investors. Exhibit 5 categorizesthese metrics according to the three key compo-nents of TSR—fundamental value, valuationmultiple, and free-cash-flow yield. The combina-tion of sales growth and change in margins(resulting in growth in EBITDA, or earnings

12 BCG REPORT

8. The average percentage of market value in 2004 attributable to expectation premiums is higher in Exhibit 4 than in Exhibit 3. This difference is dueto the different samples analyzed in each exhibit. Exhibit 3 calculates expectation premiums for selected companies of the U.S. S&P 400, the only dataset for which we have long-term historical data. Exhibit 4 calculates expectation premiums for the 596 companies in our 12-industry global sample. Sincethis second sample includes larger companies, on average, and since larger companies tend to benefit from higher investor expectations, the 2004 aver-age expectation premium in Exhibit 4 is slightly higher.

Exhibit 6 also confirms the growing spread ininvestor expectations between average companiesand the best. Because EBITDA multiplesdecreased for the sample as a whole, they actuallyoffset 3 percentage points of TSR each year.Improvements in EBITDA multiples in the topdecile, by contrast, accounted for an additional 5.9percentage points of annual TSR.11

But the biggest differentiator between the twogroups is the change in their levels of debt.Because the best-performing companies were gen-erating additional cash, they were able to use someportion of that cash to reduce their debt—anaction that was responsible for an additional 8.4 percentage points of TSR. The sample as awhole, by contrast, actually increased debt, whichoffset one percentage point of TSR. In otherwords, paying down debt turns out to be an impor-tant contributor to the superior returns of the topperformers. (Of course, this is not to say that allincreases in debt have negative impacts on TSR. Itmay be that some of the debt taken on by theentire sample was used for investments that con-tributed to profitable growth.)

Finally, it is interesting to note that the top decilewas just as aggressive in paying out dividends asthe average company. For both groups, dividendyield contributed 2.1 percentage points of TSR.Clearly, the significant margin improvement of thetop performers has allowed them not only to

13The Next Frontier

9. In past reports, we criticized some companies’ overreliance onEBITDA as a value-management metric. (See Succeed in Uncertain Times,BCG Value Creators report, November 2002, pp. 19–20.) Because itleaves out key expenses such as capital expenditures, EBITDA is a lessreliable measure of profitability than cash-based measures like cashflow return on investment and cash value-added. And because it ne-glects the balance sheet, it is not really an accurate proxy for a com-pany’s free cash flow. However, EBITDA is still commonly used byinvestors as an indicator of a company’s earnings-growth potential. Aslong as it is not a company’s sole or primary value-management metricfor planning purposes, it still has analytic value.

10. The EBITDA multiple is the ratio of enterprise value (the marketvalue of equity plus the market value of debt) to EBITDA and is fre-quently used by investors as a rough measure of a company’s futureexpectations. We have chosen to use the EBITDA multiple (ratherthan, say, a company’s P/E ratio) in this study because many of thecompanies in our sample posted negative earnings in some years ofour study. For more detail on this issue, see the sidebar on p. 32.

11. Turnarounds represent a special case. When a company has low or negative earnings, it can have a relatively high EBITDA multiplesimply because the denominator in the ratio is unusually low. As thecompany’s performance improves and earnings increase, its multiplewill decline. But whatever penalty this imposes on its valuation multi-ple will be countered by the contribution to TSR of its improvedearnings.

before interest, taxes, depreciation, and amortiza-tion) serves as a rough indicator of a company’simprovement in fundamental value (box 1 in Ex-hibit 5).9 The EBITDA multiple is used as a measureof a company’s valuation multiple (box 2).10 Finally,dividend yield, change in shares outstanding, andnet debt change are all forms of distribution of freecash flow to investors (box 3). Using this model, wecan analyze a company’s TSR and determine howmany percentage points of TSR can be attributed toeach of these six factors. (For a discussion of thebenefits of these investor-oriented metrics for man-agers, see the sidebar “Two Approaches toAnalyzing TSR,” page 16.)

Exhibit 6, page 14, portrays this TSR decomposi-tion profile for our 596-company global sample asa whole and for the top decile. For both groups,sales growth was by far the biggest contributor toTSR—accounting for 11.8 percentage points forthe top decile and 5.6 percentage points for thesample as a whole. But margin improvement wasan even bigger differentiator between the twogroups: although it accounted for only 1.1 per-centage points of TSR for the entire sample, it wasresponsible for 6.5 percentage points of TSR forthe top decile. In other words, the best-perform-ing companies were able to improve their marginseven as they grew their businesses.

E X H I B I T 5

TSR DECOMPOSITION MODEL

SOURCES: Thomson Financial Datastream; Thomson Financial Worldscope;

Bloomberg; BCG analysis.

NOTE: Numbers are for illustrative purposes only.

Free cash flow

TaxesReinvestment

Fundamental value

Sales growth 3.8%Margin change –0.5%EBITDA growth 3.3%


Dividend yield 3.4%Share change 2.3%Net debt change –2.3%Free-cash-flow yield 3.4%

TSR9.9%

Capitalgains6.5%

Free-cash-flowyield3.4%

1.

3.

2. Valuation multiple

EBITDA multiple change 3.2%

14 BCG REPORT

E X H I B I T 7

TSR DECOMPOSITION PROFILE, PULP-AND-PAPER INDUSTRY, 1999–2003


NOTE: Bars show contribution of each factor in percentage points of five-year average annual TSR.

Valuation multipleFundamental value Free cash flow

7.1%6.1%

2.5%

–1.8%

4.8%3.2%

5.2%3.6%

5.8%

0.9%–0.4%

–3.0%

Sales growth EBITDA margin change EBITDA multiple change Dividend yield Share change Net debt change

Top ten performers Total sample, n = 29

E X H I B I T 6

TSR DECOMPOSITION PROFILE, GLOBAL SAMPLE, 1999–2003


NOTE: Bars show contribution of each factor in percentage points of five-year average annual TSR.

Valuation multipleFundamental value Free cash flow

11.8%

5.6%6.5%

1.1%

5.9%

–3.0%

2.1% 2.1%

8.4%

–1.0%

–4.8% –4.8%

Sales growth EBITDA margin change EBITDA multiple change Dividend yield Share change Net debt change

Top decile, n = 60 Total sample, n = 596

15The Next Frontier

invest in new growth and pay down debt but also toreturn cash to investors in the form of dividends.

A Renewed Focus on Direct Distributions of FreeCash Flow. The commitment of the top perform-ers to paying down debt and paying out dividendsmay represent the beginnings of a trend. In thedouble-digit TSR environment of the 1990s, directdistributions of free cash flow to investors consti-tuted a relatively minor contribution to TSR. Butin a market environment where average annualreturns are apt to be in the single digits, dividendsand other distributions of free cash flow are likelyto become a far more important component of acompany’s total TSR package. Historically, distri-butions of free cash flow in the form of dividendsand share repurchases have represented roughly35 to 45 percent of market-average TSR. And therehas been a shift in investor sentiment in favor oflow-risk, high-payout value-creation strategies thatconsistently produce returns slightly above themarket average—as opposed to high-risk strategiesdriven by aggressive growth and aiming at top-quartile or better performance.12

For an example of an industry where distributionsof free cash flow have played a significant role ingenerating TSR, consider Exhibit 7. It presents theTSR decomposition profile for the pulp-and-paperindustry, which posted the highest five-year TSR inour 12-industry sample—9 percent, on average.The exhibit shows that dividend yield is responsi-ble for an above-average share of TSR—3.6 per-centage points, on average, for the sample as awhole, and a full 5.2 percentage points for the topten performers in the industry. What’s more, debtrepayments accounted for an additional 5.8 per-centage points of TSR for the top ten. For thesecompanies, in short, the combination of just twoactions—paying out dividends and paying downdebt—generated enough TSR to beat the industryaverage.

In the lower-return market environment of thefuture, companies will need to take advantage ofthe full range of drivers of TSR and develop anintegrated approach for managing the tradeoffsamong them. The next section makes the case foran integrated value-creation strategy.

12. For a more detailed discussion of these trends, see “Prioritizing the Uses of Free Cash Flow,” p. 37.

16 BCG REPORT

Both managers and investors see above-average TSRas the ultimate goal of value creation. However, eachgroup analyzes TSR performance in a somewhat dif-ferent way. This year’s Value Creators report blendsthe two approaches in an integrated methodology.

Over the last two decades, many companies haveembraced the principles of value management as thebest way to improve a company’s TSR. Value man-agement focuses on the actions that will improve acompany’s fundamental value. And its cash-basedmetrics—including cash flow return on investment(CFROI), cash value-added, economic profit, andtotal business return, among others—have become astandard part of the corporate-finance lexicon atmany companies.

The exhibit below charts the financial performanceof Qualcomm, this year’s number one large-cap top

T W O A P P R O A C H E S T O A N A L Y Z I N G T S R

performer, using traditional value-management met-rics. It shows that although Qualcomm’s TSR washighly volatile during the period from 1999 through2003 (a function of the boom and subsequent crashin the technology sector), its superior performance—an annual average TSR of 53 percent—was basedon a solid foundation of extraordinary improvementin CFROI. Qualcomm more than tripled its CFROIlevel during this time period, mainly throughimprovement in cash-flow margins. And althoughthe company’s investment growth dropped signifi-cantly in the postboom recession, the company wasstill able to slightly outpace industry-average growthrates during the entire period.

Value management’s cash-based metrics have twogreat advantages. First, they track the source of fun-damental value, which, research has shown, drivesa company’s TSR over the long term. Second, they

VALUE CREATION AT QUALCOMM, 1999–2003 ( I )


1Company values (bars) correspond to left axis; industry sample values correspond to right axis.

Total technology industry sample, n = 81Qualcomm

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

0

500

1,000

1,500

2,000

2,500

3,000

100

838780

1,270

2,720

562

100130 87672031000

5

10

15

20

25

30

35 30.333.2

10.312.2

21.3

31.7

7.87.36.78.18.88.8

0

5

10

15

20

25

3024.5 25.8

5.77.5

23.0 24.3

12.7 13.714.1

13.612.5

13.0

–1,000

–500

0

500

1,000

’98 ’99 ’00 ’01 ’02 ’03

–100

–50

0

50

100

10 56

399 454 517

807

0

50

100

150

200

100

166

110

185

130

132

170

154 157

158

120100

0.0

0.5

1.0

1.5

2.0

1.2 1.31.3

0.9

1.61.8

0.60.60.50.60.7 0.7

Total shareholder return

Cash value-added1

Profitability

Investment growth Asset productivity

Cash flow margin

Gross investment index (1998=100)

CFROI (%)TSR index (1998=100)

Sales/gross investment

Cash flow/sales (%)

$millions $billions

provide a way for companies to translate their TSRtargets into operational metrics that line managerscan actually influence. That’s why BCG has longchampioned value-management concepts and usedcash-based metrics as the underlying foundation ofthe Value Creators reports.1 In recent years, we haveintroduced important refinements in the system—forexample, the concept of the expectation premium tohelp analyze that portion of a company’s marketvalue that is not explained by its underlying funda-mental value.

Investors also care about fundamental value and theexpectations embedded in a company’s stock price,but they tend to rely on a more traditional set of met-rics for assessing these contributors to TSR. They arerelentless in assessing the outlook for revenuegrowth and margins. But they also spend consider-able time and effort assessing a company’s valuation

multiple—in an effort to determine whether a com-pany is over- or undervalued and what its targetmultiple ought to be. And all but the most aggressivegrowth investors are also highly sensitive to howmuch free cash flow a company pays out in the formof dividends, debt repayment, or share buybacks. Totrack these aspects of value creation, they use abroader set of metrics, including revenue growth,margins, price-to-earnings ratios, and dividend yield,among others. (The exhibit below illustrates one ver-sion of this investor’s view of TSR.)

The exhibit on page 18 provides an alternative viewof Qualcomm’s performance in terms of theseinvestor-oriented metrics. It confirms that the com-pany’s value creation was founded on margin

17The Next Frontier

AN INVESTOR-ORIENTED MODEL OF TOTAL SHAREHOLDER RETURN


Profitability variables(e.g., gross margin)

Cost efficiency variables(e.g., inventory turnover)

Leverage variables(e.g., debt-to-capital ratio)

Other variables(e.g., dividend payout)

Industry specific variables(e.g., R&D as % of revenue)

EBITDA margin change

Growth variables(e.g., asset growth)

Capital gain


TSR

Sales growth

ƒ

X

ƒ

+

x

EBITDA growth

EBITDA multiple

Dividend yield

Share buybacks

Debt repayment

1. For a more detailed discussion of fundamental-value metrics, see“Improving Fundamental Value,” on p. 23.

improvement considerably above the industry aver-age, not on sales growth, which was actually belowthe industry average for this period. It also allows usto calculate how many percentage points of TSRwere due to sales, margins, multiple improvement,and dividend yield. For example, although the crashin the technology sector caused Qualcomm’s multi-ple to decline dramatically from 1999 to 2000, itstill grew over the course of the entire 1999–2003period and was responsible for a full 18 percentagepoints of Qualcomm’s average annual TSR. One keydriver of this high multiple was the company’s majorimprovement in margins, which is an important

T W O A P P R O A C H E S T O A N A L Y Z I N G T S R ( c o n t i n u e d )

signal for investors of the sustainability of futureEBITDA growth.

To understand the value of combining these two setsof metrics, consider the analogy to human sight. Justas it takes two eyes to produce stereoscopic visionand accurate depth perception, so it takes boththese analytical lenses to develop a rich understand-ing of what is driving value creation in a business.Managers can use these investor-oriented metrics tounderstand and manage dimensions of value cre-ation, such as relative valuation multiples and free-cash-flow yield, that they have not typically consid-ered a high priority in the past.

18 BCG REPORT

VALUE CREATION AT QUALCOMM, 1999–2003 ( I I )


1Industry calculation based on aggregate of entire sample.

2Share change and net debt change not shown.

3Industry calculation based on sample average.

Total technology industry sample, n = 81Qualcomm

100

838780

1,270

2,720

562

100130 8767203100

100

100109

125 128 125

119

80

95

118

91

127

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

0

500

1,000

1,500

2,000

2,500

3,000

60

7080

90100

110120

130

140

05

1015202530354045

11.5

41.6

34.634.6

14.3

35.4

21.224.2 23.621.7

23.522.3

–10–5

05

101520253035

40

18

32

1

–4

16

0

50

100

150

200

250

11.0

23.439.1

200.6

23.811.712.9

54.1

8.7

8.220.111.5

0

1

2

0.0

0.9

0.00.00.0 0.0

0.60.4

1.2

0.7

1.31.1

ƒ


Simplified five-year TSR decomposition2

Sales growth

EBITDA multiple1 Dividend yield3

EBITDA margin1

TSR index (1998=100) Sales index (1998=100) EBITDA/revenue (%)

TSR contribution (%) Enterprise value/EBITDA (x) Dividend/stock price (%)

Salesgrowth

Marginchange

Multiplechange

Dividendyield

19

The Case for an Integrated Value-Creation Strategy

Creating a robust value-creation strategy is a com-plex and multidimensional task. Executives need toask questions about fundamental value, the under-lying economic engine on which value creation ulti-mately rests. For example: “What level of profitabil-ity should we target?” “How much can we grow?”“Does the source of that growth matter?” “How doesgrowth interact with our profitability goals?”

At the same time, they need to anticipate the likelyresponses of investors to the decisions they makeand the impact of their choices on the company’svaluation multiple. For example: “Are we fairly val-ued today?” “How will our plans affect our futureprice-to-earnings ratio (P/E)?” “What level of growthis expected by investors and already embedded inour stock price?” “What is the tradeoff betweengrowing our earnings and maximizing our P/E—and how should we manage that tradeoff?”

Finally, they need to develop a plan for the man-agement and use of free cash flow and explicitlypose questions such as “How much debt should wecarry and what should we use it for?” “What are thepriorities for the use of cash?” “What should ourdividend payout be?”

Thirty years ago, the prevailing view of how to man-age the tradeoffs across these three drivers of TSRwas extremely simple. Most strategies for value cre-ation emphasized delivering growth in earnings pershare (EPS). This approach made two key assump-tions: first, that EPS growth was a reasonable proxyfor improvements in the fundamental-value engineof a company, and, second, that the level of EPSgrowth was the primary driver of a company’s valu-ation multiple. Although executives recognizedthat payouts of free cash flow to investors also con-tributed to TSR, they tended to see them as a sec-ond-order priority. The EPS approach encouragedcompanies to take on debt in order to fund addi-tional earnings growth or to buy back shares inorder to boost EPS by shrinking the number ofshares outstanding. Most companies paid dividendsonly when all avenues for EPS growth had beenexhausted.

Over the past 20 years or so, the discipline of valuemanagement has developed a compelling critiqueof this simple value-creation strategy. Proponents ofvalue management demonstrated that in fact thereis little empirical correlation between growth inEPS and actual improvements in TSR. In addition,EPS growth is a poor proxy for improvements in theunderlying fundamental-value engine of a com-pany. Because EPS growth is an accounting con-struct, it is vulnerable to manipulations that make itlook good at the expense of a company’s actualcash flow. And since any investments above the costof debt grow EPS, the approach encourages compa-nies to take on debt even for investments that gen-erate returns below the weighted average cost ofcapital. Finally, it encourages any acquisitions thatare accretive to EPS—even those that ultimatelydestroy shareholder value by shrinking a company’svaluation multiple.

To address these shortcomings, the field of valuemanagement proposed an alternative approach,one that emphasizes the generation not of earningsbut of free cash flow. According to this view, a com-pany’s fundamental value is determined by itsactual discounted cash flow. And because capitalmarkets are efficient, improvements in fundamen-tal value translate into improvements in a com-pany’s stock-market value over time. Value manage-ment developed a variety of new metrics—cash flowreturn on investment (CFROI), cash value-added(CVA), economic profit, total business return—thatallow companies to more accurately measure andmanage a company’s fundamental value.

From this new cash-based perspective, the hurdlefor new investments is not the cost of debt butrather the weighted average cost of capital. Anygrowth below the cost of capital destroys valueinstead of creating it. Finally, acquisitions createvalue only if they are profitable over time (that is, ifthey produce a positive net present value, or NPV),not simply increase EPS on the date of transaction.

Value management has helped many companiesfocus internal decision-making squarely on increas-

The Next Frontier

20 BCG REPORT

It is extremely difficult for a company to beat themarket average consistently, year after year. Welooked at a broad sample of 1,727 global compa-nies with a market valuation of more than $1 bil-lion to see how many years they have beat theirlocal market average. As the exhibit to the rightillustrates, we found that only seven have done soin nine of the last ten years.

The Korean electronics giant Samsung is the onlyglobal top performer this year that is a member ofthis exclusive club. From 1999 through 2003, thecompany posted average annual TSR of 44 per-cent, putting it in the number two position in ourlarge-cap top ten. As the first Samsung exhibitshows, Samsung was able to grow its fundamentalvalue during this period by 20 percent per year—despite significant erosion in its CFROI, whichdeclined from 27 to 12.3 percent. The companywas able to overcome this drop in profitabilitythrough rapid growth. Samsung more than doubled

T H E V A L U E - C R E A T I O N C H A L L E N G E

NUMBER OF YEARS COMPANIES HAVE OUTPERFORMED LOCAL MARKET, 1994–2003


0

100

200

300

400

500

600

0 1 2 3 4 5 6 7 8 9 10

Companies

469

239

60

7 00

485

125

435

294

Yearsn = 1,727

VALUE CREATION AT SAMSUNG, 1999–2003 ( I )



Total technology industry sample, n = 81Samsung

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03–100

–50

0

50

100

56

399

0

100

200

300

400

500

600

700

100

100

623

375

207

346428

100130 8767

203

0

5

10

15

20

25

30

15.712.3

12.6

27.0

19.2

9.4

7.87.36.78.18.88.8

0

5

10

15

20

13.7

10.011.5

18.3 17.4

8.9

$millions $billions

12.7 13.7

14.113.6

12.5

13.0

–3,000

–1,500

0

1,500

3,000

232

1,7762,326

–1,349

1,828

–437

0

50

100

150

200

250

100

224

188169

93

218

170154 157158120

100

0.00.2

0.40.60.8

1.01.2

1.41.6

1.2 1.21.11.1

1.5

1.1

0.60.60.5

0.60.7 0.7


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

its gross investment during this period, and salesgrowth contributed a full 21 percentage points toits average annual TSR.

The second Samsung exhibit shows that anotherkey source of Samsung’s superior performance wasimprovement in its valuation multiple relative toindustry peers. In 1998, the company’s EBITDAmultiple was less than half that of the industryaverage. But Samsung was able to grow its multi-ple despite the crash in investor expectations in thetechnology sector. By 2003, Samsung’s multiplewas only slightly below the industry average. Thisimprovement in the company’s relative multiple

contributed ten percentage points of TSR per year.

From an investor ’s perspective, there are severalcritical questions facing Samsung’s future value-creation strategy. How sustainable is the com-pany’s recent revenue growth? Can the companymaintain or even improve its margins—for exam-ple, by migrating to new higher-margin opportuni-ties? How should the company manage the tradeoffbetween additional growth, margin improvement,and dividend yield? Can Samsung expect furtherimprovements in its currently below-averageEBITDA multiple?

21The Next Frontier

VALUE CREATION AT SAMSUNG, 1999–2003 ( I I )





Total technology industry sample, n = 81Samsung

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

0

100

200

300

400

500

600

700

100

623

375

207

346

428

1001308767203

10060

110

160

210

260

310

100

100 109125 128 125

252

180169

125

227

127

0

5

10

15

20

25

30

19.016.316.3

27.826.5

21.921.224.2

23.6

21.723.5

22.3

–10

–5

0

5

10

15

20

25 21

3

10

–3

1

–4

16

0

5

10

15

20

25

4.57.17.8

3.35.5 4.9

11.712.9

8.78.2

20.1

11.5

0

1

2

3

4

5

3.0

1.8

4.1

0.5

3.7

1.9

0.6

0.4

1.20.71.31.1

ƒ



Sales growth


EBITDA margin1



Salesgrowth

Marginchange

Multiplechange

Dividendyield

22 BCG REPORT

ing fundamental value. In many instances, it hasimproved the management of existing capitalemployed and brought a more explicit value-cre-ation focus to incremental investment decisions.More recent BCG research and client work, how-ever, have identified three important refinementsof the traditional value-management model:

• Although improvements in fundamental valueare the source of long-term improvements inTSR, how a company goes about improving fun-damental value can have either positive or nega-tive impacts on its valuation multiple. Executivesneed to anticipate these impacts and manage thesubsequent tradeoffs. Otherwise, they mayimprove fundamental value only to see their TSRdecline in the near term.

• A company’s valuation multiple, relative to indus-try peers, is an important signal of how investorsevaluate risk, sustainability, quality, and competi-tive advantage over the long term. It can be a sig-nificant enabler of—or constraint on—a com-pany’s value-creation strategy. A weak multiplecan raise a company’s cost of capital. It can alsoput a company at a disadvantage when it comes toacquisitions (because its stock will be a relatively

weaker acquisitions currency), thus precludingone important pathway to growth. Indeed, it caneven increase the risks of takeover by signaling tocompetitors that a company is undervalued rela-tive to its peers. Although managers tend to seetheir valuation multiple as something largely out-side their control, in fact it is possible to identifythe specific drivers of multiples in a particularindustry and to predict how specific companyactions will affect it.

• Investors have expectations not only for a com-pany’s capital gains but also for how much free cashflow it ought to distribute to investors. Whether ornot a company pays dividends, and at what level,can have a major impact both on its near-term val-uation multiple and on its long-term strategy forimproving fundamental value. For this reason, theuse of free cash flow also needs to be an integralpart of a company’s value-creation strategy.

By addressing these areas, managers can develop atruly integrated value-creation strategy, one thatcreates a balance between near-term and long-termvalue creation and allows them to manage thetradeoffs across the entire value-creation system.Let’s consider each area in turn.

23

Improving Fundamental Value

Improvements in fundamental value, long the focusof traditional value management, remain at the coreof an integrated value-creation strategy. In previousValue Creators reports, we have consistently empha-sized the centrality of fundamental value to long-term TSR. This year, we reaffirm that centrality—andaddress an additional set of tradeoffs that executivesmust manage in order to achieve a balance betweenshort-term and long-term TSR.

Fine-Tuning the Fundamental-Value Engine. Acompany’s fundamental value is a function both of returns, measured by CFROI (cash flowreturn on investment), and of profitable growth in the asset base of the business. There are two ways a company can boost returns: either by increasingits cash flow margins or by improving the produc-tivity of its existing assets—in effect, doing morewith less.

Improving CFROI means that a company isproducing more cash per dollar of investment. Thisboosts earnings and net present value. By makingmore cash available for investment, it also signalsinvestors to expect increased value from futureinvestments, thus raising not only a company’s cashvalue-added but also its valuation multiple.

The precise impact of improvements in CFROI ona company’s stock price depends, in part, on theindustry context—in particular, whether investorswill consider an increase in CFROI as transitory orsustainable. Consider the example of this year’snumber four large-cap top performer, Nissan. Inthe late 1990s, Nissan was facing a severe financialcrisis. The company was saddled with $30 billion indebt and had lost money in half of the previousten years. In 1999, French automaker Renault tooka 37 percent stake in the company and engineered

The Next Frontier

E X H I B I T 8

VALUE CREATION AT NISSAN, 1999–2003 ( I )



Total automotive industry sample, n = 42Nissan

7.99.2

5.15.1 5.64.5

6.6

5.85.1

6.67.16.2

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

050

100150200250300350400

100

368

203190

116

273

9999 11286

117100

0

2

4

6

8

10

0

2

4

6

8

10

12

8.9

5.3 5.5

9.8

4.4 4.6 4.6

6.66.46.65.8

6.2

–4

–2

0

2

4

–60

–30

0

30

60

–2.3 –2.2–3.0

–1.7–1.1

1.9

020406080

100120140160

100

129109108

94

123

132122

145140

110100

0.4

0.6

0.8

1.0

1.2

1.4

0.9 0.91.01.0

1.21.2

0.90.91.01.0

1.1 1.1


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

24 BCG REPORT

E X H I B I T 9

VALUE CREATION AT NISSAN, 1999–2003 ( I I )





Total automotive industry sample, n = 42Nissan

100

368

203190

116

273

9999 11286

117100 9.0

16.1

10.7

8.69.2

13.8

9.6

11.0

10.910.7

11.711.1

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

0

50

100

150200

250

300

350

400

80859095

100105110115120125130

100

100

109

117 118121

124

104

9391

10094

6

8

10

12

14

16

18

–202468

101214

1 10

12

23

0

5

5

6

7

8

9

10

7.2

7.1

8.3

9.5

6.0

8.28.7

7.3

8.0

7.2

7.3

7.1

–1

0

1

2

3

4

0.8

2.4

0.9

0.0 0.0

1.81.81.5

3.3

1.4

1.71.3

ƒ



Sales growth


EBITDA margin1



Salesgrowth

Marginchange

Multiplechange

Dividendyield

the appointment of Renault vice president CarlosGhosn as Nissan’s first non-Japanese CEO. Ghosninstituted a sweeping reorganization of the com-pany—closing inefficient factories, reducing thework force, curbing purchasing costs, and sharingcertain operations with Renault.

Exhibit 8, page 23, and Exhibit 9, below, capturethe highlights of Nissan’s five-year financial per-formance under Ghosn’s leadership. Clearly, thecompany has put a priority on improving its below-average margins as opposed to growing the com-pany. Between 1999 and 2003, Nissan more thandoubled its cash-flow margins—from 4.4 percent to9.8 percent. The resulting increase in CFROIhelped fund an increase in dividend payout, whichwent from 0 in 1999 to 12 percent of earnings in2003. The combination of improved fundamentalvalue and increased dividends gave Nissan an aver-age annual TSR of 30 percent during this period.

From 1999 through 2003, Nissan’s multiple re-mained flat and dropped somewhat below the indus-try average. It may be that investors are waiting tosee, first, whether Nissan can sustain these high mar-gins in the highly competitive auto industry, and, sec-ond, whether the company can capitalize on itsabove-average margins through profitable growth.

The Imperative of Growth. Over the past five years,Nissan has used increases in CFROI (driven largely bymajor improvements in margins) to achieve globaltop-performer status. And yet, on their own, suchimprovements are not enough to sustain superiorTSR over the long term. It is extremely difficult toimprove margins or increase asset productivity yearafter year. Margin improvements are often competedaway. Once a company has harvested the low-hangingfruit, reductions in the cost of goods sold or in sell-ing, general, and administrative expenses tend tohave diminishing returns. Improvements in asset pro-

ductivity are also harder to achieve once a companyhas addressed the obvious opportunities such as opti-mizing working capital, raising asset utilization, andreengineering its supply chain. For companies thatare approaching best practice in terms of operationalefficiency, continued improvements in CFROI arelikely to contribute a relatively modest 1 to 3 percentof TSR per year. Such gains may be important in amarket delivering average returns of 7 to 9 percentper year, but on their own they are unlikely to carry acompany into the top quartile.

That’s why, for improved CFROI to have its optimumimpact on value creation, it must be translated intoprofitable growth. Investing in growth allows compa-nies to compound the value of their CFROI by direct-ing the cash they produce into new opportunitiesthat earn returns above the cost of capital. Over thelong term, growth is by far the most important con-tributor to a company’s TSR.

BCG’s methodology for breaking down TSR into itsconstituent parts suggests just how important. Exhibit10 profiles the average annual TSR of the U.S. S&P500 for the 20-year period from 1984 through 2003.The exhibit compares the relative contribution ofthe drivers of fundamental value—margins andgrowth—as well as the contribution of changes in val-uation multiples and dividend yield. The chart onthe top shows that for average TSR companies,growth is consistently the most important contribu-tor to TSR over both the short and the long term,responsible for roughly three-quarters of the total.The chart on the bottom shows that for the top-quar-tile companies, other factors—in particular, im-provements in multiples—can loom large in theshort term, but that over a 20-year time frame,growth assumes a predominant role.

This basic historical trend is reinforced by findingsfrom this year’s Value Creators study. For example,28 percent of the companies in our global samplegrew their gross investment by 10 percent per year,on average, between 1999 and 2003, but a full 43 percent of the companies in the top tenth ofthe sample did so—a sign that growth is a key tosuperior performance.

What’s more, other BCG research suggests thatinvestors consider growth so important that theydon’t care where it comes from—that is, whether itis the result of “organic” internal investments or

25The Next Frontier

E X H I B I T 1 0

TSR DECOMPOSITION PROFILES, U.S . S&P 500, 1984–2003

SOURCES: Compustat; BCG analysis.

S&P 500 average

0

10

20

30

40

50

1 5 10 20

TSR (%)

TSR (%)

Top-quartile average

Time span in years

Time span in years

0

10

20

30

40

50

1 5 10 20

Dividend yield Change in multiple

Margin improvement Growth

comes by way of acquisitions—as long as it is prof-itable. We recently compared the stock-marketperformance of 705 public U.S. companies for theten-year period 1993 to 2002 based on their levelof M&A activity. We found that, on average, high-growth companies generated higher returns nomatter what type of growth strategy they pursued.Across the three strategies in our study—organic,acquisitive, and mixed—the fast growers outper-formed the slow growers by roughly 6 to 7 percent,on average.13

For an example of a global top performer that hascreated value through above-average growth, con-sider the case of Sysco. Based in Houston, Texas,Sysco is North America’s largest food-servicedistributor and the number six large-cap topperformer in this year’s study. The $26 billioncompany provides systems and services for “meals

prepared away from home” operations such asrestaurants (including major fast-food chains suchas Wendy’s), nursing homes, hospitals, and otherinstitutional customers.

One source for Sysco’s rapid growth has been itsinnovative “fold-out” expansion program in whichthe company turns profitable distribution centersserving new markets into stand-alone companies.Sysco’s innovative decentralized structure allows thecompany to combine high presence in local marketswith the advantages of scale—it is by far the largestplayer in a highly fragmented industry. Anothermajor source of growth is the company’s frequentacquisitions of local distributors of specialty fooditems serving growing niche markets.

As a wholesaler, Sysco has relatively low margins com-pared with the consumer-goods industry as a whole.But its very high asset turnover means it generatesCFROI well above the cost of capital. (See Exhibit11.) When these returns are combined with Sysco’s

26 BCG REPORT

E X H I B I T 1 1

VALUE CREATION AT SYSCO, 1999–2003 ( I )



Total consumer goods industry sample, n = 68Sysco

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

0

50

100

150

200

250

300

350

100

289

197223

146

228

103108 1129895100

8

10

12

14

16

18 16.9 16.8

11.6

13.214.2

15.0

17.4

11.611.411.612.312.6

0

2

4

6

8

10

12

3.7

11.1 11.2

3.73.0 3.0 3.2 3.6

10.810.410.211.1

0

100

200

300

400

500

600

0

30

60

120 157

216

351390

556

020406080

100120140160180

100

163

130118

104

146138129

144139107

100

0.4

1.4

2.4

3.4

4.4

5.4

4.6 4.64.84.74.84.4

1.01.11.01.11.2 1.2


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$millions $billions

13. See Growing Through Acquisitions: The Successful Value Creation Recordof Acquisitive Growth Strategies, BCG report, May 2004.

well-above-average growth rate, the result is an aver-age annual TSR of 23.6 percent during the entirefive-year period. Sysco’s high CFROI funds not onlysubstantial growth but also its relatively high divi-dend payout of 34 percent of earnings. The overalldividend yield contributes an additional two per-centage points of TSR, on average. (See Exhibit 12.)

Managing Tradeoffs Around Growth. Improvementsin fundamental value—especially in profitablegrowth—are key to value creation in the long term.But in the short to medium term, a company mustcarefully weigh the tradeoffs between investments ingrowth and the impact of those investments on theother dimensions of TSR—the valuation multipleand alternative uses of free cash flow.

There are situations where profitable growthimproves fundamental value but does not increasea company’s stock price by an equivalent amount.

In some cases, the company’s TSR remains flatbecause the increase in fundamental value is sim-ply justifying expectations that are already builtinto the company’s stock price. In more extremecases, investor expectations have pushed the stockprice so high that the company is unable todeliver. In either situation, companies must findadditional sources of growth (whether organicallyor through acquisition), focus on other drivers ofTSR (for example, improving margins or freeingup cash to pay out as dividends)—or resign them-selves to living with a declining valuation multipleand therefore lower TSR.14

In other situations, the precise way a companygrows can have a differential impact on its valua-

27The Next Frontier

E X H I B I T 1 2

VALUE CREATION AT SYSCO, 1999–2003 ( I I )





Total consumer goods industry sample, n = 68Sysco

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

0

50

100

150

200

250

300

350

100

289

197223

146

228

103108 1129895100

8090

100110120130140150160170180

100

100 102111 114 118 120

142

126

114

152

171

02468

101214161820

5.06.15.95.35.0

6.2

17.116.8 17.516.916.215.9

–6–4–2

02468

101214 12

4 42

42

–5

2

7

9

11

13

15

17

19

21

13.1

15.614.2

20.2

16.0

14.2

10.611.6

9.89.711.2

12.4

0

1

2

3

4

1.7 1.8

0.9

1.81.4

1.9

2.3

3.12.8

2.22.02.2

ƒ



Sales growth


EBITDA margin1



Salesgrowth

Marginchange

Multiplechange

Dividendyield

14. See Succeed in Uncertain Times, BCG Value Creators report, November 2002, and Back to Fundamentals, BCG Value Creators report, December 2003.

tion multiple. It’s important to realize thatinvestors don’t only have expectations about acompany’s level of growth. They also have expec-tations about the sustainability of that growth, itsvolatility, and its degree of risk, as well as about thecompany’s capital structure and brand strength.The company needs to focus not on any profitablegrowth but on the type of growth that is best suitedto the specific drivers of valuation multiples in itsindustry and to its current mix of investors.

By way of illustration, consider the situation of abranded consumer-products company. Typically,investors in such companies require that growthbe accompanied by strong gross margins, becausethey see strong margins as a sign of the long-termsustainability of the brand. When such companiesgrow—but at the cost of weakening margins—theymay improve their fundamental value only to seetheir valuation multiple, and overall TSR, suffer.Alternatively, when these companies are able tocombine strong growth with higher margins, theywill see a double benefit—not only improved fun-damental value but also a higher multiple.

Finally, every investment in growth also needs tobe weighed against potential alternative uses ofthe same cash. Growth investments are not surebets; projected returns are often highly uncertain.In many companies, it may make sense to assessthe TSR impact of using the cash needed for theleast promising 20 percent of a company’s growthinitiatives to retire debt, pay dividends, or repur-chase shares. Depending on the drivers of valua-tion multiples in the industry and a company’sinvestor mix, these alternative uses of cash mayboost TSR more than investing in lower-return orhigher-risk growth opportunities.

Arriving at the right combination of near-term andlong-term moves is highly specific to the companyand the industry. That’s why, although fundamen-tal value is critical to long-term value creation, nocompany should focus on it exclusively—to theneglect of other components of its TSR package.In the short to medium term, there may be otheropportunities to improve TSR that can disciplinerather than erode its ability to improve fundamen-tal value over the long term.

28 BCG REPORT

29

Exploiting Valuation Multiples

Fundamental value drives TSR performance overthe long term. But at any particular moment intime, investor expectations can push a company’sstock price significantly above—or below—thecompany’s fundamental value.

In previous Value Creators reports, BCG intro-duced a new metric, the expectation premium, tomeasure the impact of investor expectations on acompany’s stock price.15 The expectation premiummeasures the difference between a company’sactual market value and the value derived from ananalysis of its underlying fundamentals.

After reaching historically unprecedented highs in2000, average expectation premiums have beendropping consistently during the past three years,to the point where fundamental values and actualmarket values are roughly equivalent. (See Exhibit3, page 11.) But that doesn’t mean that expecta-tion premiums have ceased to be important. Froma managerial perspective, what really matters isnot the absolute value of a company’s expectationpremium but the relative value compared with in-dustry peers.16 Our analysis shows that the diver-gence between average expectation premiums andthose of the top performers has actually beengrowing. (See Exhibit 4, page 11.) For companieswith expectation premiums below the industryaverage, improving them in order to increaseshareholder value in the near term may have ahigh priority—particularly in industries that areconsolidating or where M&A is the preferred pathfor growth.

But to do so, executives need a way to identify—and influence—the drivers of relative expectationpremiums. This year, in an extension of our expec-tation-premium work, we introduce a new method-ology called comparative multiple analysis.

Comparative Multiple Analysis. Our approach usesa company’s valuation multiple as an indicator of

investor expectations. We use statistical regres-sions to identify correlations between the range ofmultiples in a given industry and a comprehensiveset of financial and operational variables—includ-ing growth, profitability, risk, sustainability, anduses of free cash flow. Using this approach, wehave found it possible to accurately identify whatdifferentiates multiples in an industry and, in thisway, explain why different companies have differ-ent multiples.

Exhibit 13, page 30, portrays the results of theregression analysis for 3 of the 12 industries in oursample: consumer goods, industrial goods, andpharmaceuticals and biotech.17 We correlated theobserved multiples in these industries from 1999to 2003 against more than 100 different variables.The list of priority drivers shows the most impor-tant factors influencing the variation of multiplesin each industry. So, for example, differences ingross margins are responsible for a full 97 percentof the variance in multiples in our consumer-goods sample, 37 percent in industrial goods, and62 percent in pharmaceuticals and biotech. Thescatter diagrams plot the actual multiples of thecompanies in each sample against the predictedmultiples derived from the regression analysis.(Each dot represents a single company’s actualmultiple plotted against its predicted multiple forone of the five years analyzed.) The correlationcoefficients (R2s) for these analyses range from .70for pharmaceuticals and biotech (in other words,the model predicts 70 percent of the actual varia-tion of multiples in the industry) to .90 for indus-trial goods.

We can draw at least four conclusions from thisanalysis. First, the drivers of multiples in an indus-try can be quantified with a reasonably highdegree of accuracy. Second, major differences inmultiples within an industry are largely the resultof factors that managers can control. Third,

The Next Frontier

15. See Dealing with Investor Expectations: A Global Study of How Today’s Top Corporations Can Generate Value Tomorrow, BCG Value Creators report, November 2001.

16. See “The Continuing Relevance of Investor Expectations,” BCG Perspectives, December 2001.

17. For reasons of data availability, we have conducted this analysis on U.S. companies only and included companies below the industry market-valuationhurdles used in our 596-company global sample.

because our statistical model is based on five yearsof data, these drivers are relatively stable overtime. Fourth, while many of the factors influenc-ing multiples across industries are the same (forexample, gross margins and net-debt ratios showup on the list for all three industries), the relativeweight of these factors is significantly different—and some factors that are extremely important inone industry have little importance or none at all in others.

In consumer goods, for example, differences ingross margins dominate variations in multiples—asign of the importance of strong brands in thisindustry, since high gross margins signal the pres-ence of a strong brand. In industrial goods, mar-gins remain important, but growth is also a key fac-tor—most likely a reflection of the heterogeneityof segments within this broad industry category. Inpharmaceuticals and biotech, an industry with asubstantial number of small startups, company sizehas a significant impact on valuation multiples, asdoes the industry-specific factor of R&D spendingas a percentage of revenue.

Exhibit 14 illustrates the major differences in mul-tiple drivers across the 12 industries in our globalsample. (The “Other” category includes industry-specific factors like R&D spending in pharmaceu-ticals and biotech.) What is particularly striking is

the importance of margins as a differentiator ofindustry multiples and the relative unimportanceof growth. At first glance, this may seem surpris-ing. After all, growth is a key driver of TSR in thelong term. And many managers assume that it isequally important to boosting a company’s valua-tion multiple. But keep in mind that Exhibit 14shows what differentiates valuation multipleswithin a single industry, not what drives total TSRor what determines the absolute level of multiplesacross industries.

There are at least two reasons why growth is rarelya differentiator of a company’s valuation multiplerelative to industry peers.

• A number of the industries in our sample (forinstance, pulp and paper) are generating CFROIthat is either below or just at the cost of capital.In such industries, investors do not anticipatethat more growth will further increase share-holder value; consequently, they do not rewardabove-average growth in a company’s valuationmultiple.

• Other industries (for example, consumer goods)do generate CFROI substantially above the costof capital. These industries enjoy a higherabsolute multiple than the low-CFROI indus-tries. But growth is not a significant differentia-

30 BCG REPORT

E X H I B I T 1 3

COMPARATIVE MULTIPLE ANALYSIS , THREE INDUSTRIES, 1999–2003

SOURCE: BCG ValueScience Center.

NOTE: R2 = Correlation coefficient.

Consumer goods Industrial goods Pharmaceuticals and biotech

Actualmultiple

Predicted multiple

Actualmultiple

Predicted multiple

Actualmultiple

Predicted multiple

R2 = .89 R2 = .90 R2 = .70

Priority drivers

1. Gross margin 97%2. Dividend payout 1%3. Net-debt-to-revenue ratio 1%4. Asset growth 1%

Priority drivers

1. Gross margin 37%2. Asset growth 19%3. Dividend payout 19%4. Net-debt-to-revenue ratio 13%5. Operating expenses as % of revenue 12%

Priority drivers

1. Gross margin 62%2. Market cap > $1 billion 14%3. R&D as % of revenue 11%4. Net-debt-to-market-cap ratio 8%5. Operating expenses as % of revenue 5%

tor of multiples within the industry—primarilybecause investors do not believe that above-aver-age growth rates are sustainable given the his-torically strong competition to maintain brandsand market share in the industry. Althoughabove-average profitable growth is rewarded inTSR through growth in fundamental value, it isnot further rewarded through improvement inthe valuation multiple.

In some industries in our sample, growth is animportant differentiator of valuation multiples. Inutilities, for example, growth matters primarilybecause of the significant differences in growth andprofit potential between the largely deregulatedgeneration companies and the regulated distribu-tion companies in this sector. (In a more narrowlydefined sample that focused on either of these twosegments alone, the importance of growth as a dif-ferentiator of multiples would be significantlyreduced.) However, in some industries—pharma-ceuticals and biotech, for example—the growththat really matters is not so much the current growthin earnings as the expected future growth as indi-

cated by R&D as a percentage of sales. (For detailsabout the specific drivers in each industry, see theanalyses in “The 2004 Industry Rankings,” page 61.)

The differences across multiples for a selectedgroup of companies become more pronouncedand more granular as the group becomes morenarrowly defined. For example, in a recent studyfor a securities brokerage company, the key differ-entiator turned out to be the ratio of self-serviceto full-service customers. A similar study in theconfectionery sector demonstrated that the keydriver of multiples was margin volatility. For a setof companies in the pulp-and-paper sector, theability to generate and distribute free cash flowturned out to be the most important differentia-tor. (For more detail on comparative multipleanalysis and how it extends BCG’s previous workon expectation premiums, see the sidebar“Expectation Premiums and Comparative MultipleAnalysis,” page 32.) The bottom line: when execu-tives develop a deeper understanding of what isreally driving their multiple relative to their peers,they can start taking actions to influence it—

31The Next Frontier

E X H I B I T 1 4

SOURCES OF DIFFERENTIATION IN MULTIPLES ACROSS INDUSTRIES, 1999–2003


Auto Chemicals Consumer Industrial Media Multibusiness Paper Pharma Retail Technology Travel Utilities0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Margin Capital structureGrowth Cost control Dividend payout Size Other

32 BCG REPORT

There are two steps to assessing the impact ofinvestor expectations on a company’s valuation:first, quantifying them relative to fundamental valueand, second, explaining the differences in expecta-tions among the company’s peer set. Analyzingexpectation premiums and comparative multiplesare complementary techniques for performing thesetwo tasks.

To arrive at a company’s expectation premium, wecalculate the current value of the company’s busi-nesses (based on margins, asset productivity, andrisk), as well as the future value likely to be gener-ated from those businesses over a given periodthrough profitable investment growth. The differencebetween the company’s actual market value and thevalue derived from this analysis of its underlying fun-damentals is its expectation premium. Expectationpremiums quantify the size of the gap between acompany’s fundamental value and its current marketvaluation. Quantifying the absolute value of a com-pany’s expectation premium can be extremely usefulin helping the company determine whether its cur-rent plans will be able to fulfill the expectations thatinvestors have for its future performance.

But the question remains why one company in agiven industry has a strong or weak expectation pre-mium relative to its peers. To answer this question,BCG developed comparative multiple analysis. Itstarts with the current market value of a companyand compares it with some key financial metric—for example, earnings in price-to-earnings (P/E)

E X P E C T A T I O N P R E M I U M S A N D C O M P A R A T I V E M U L T I P L E A N A L Y S I S

ratios, revenues in price-to-revenue (P/R) ratios, orEBITDA in EBITDA multiples. We compare theseobserved multiples within an industry with a broadrange of financial and performance data and runstatistical regressions in order to identify whatdifferentiates multiples in a specific industry. Byidentifying the precise drivers of a company’smultiple, this approach allows managers to antici-pate the impact of their actions on their company’smultiple.

Ideally, comparative multiple analysis should beapplied to a narrowly defined and homogeneousgroup and focus on the multiple that is most appro-priate given the type of companies being analyzed.For early-stage startups, a P/R multiple is generallythe most appropriate; for high-growth, capital-inten-sive businesses, EBITDA multiples tend to workbest; and for well-established average-growth com-panies, either EBIT multiples or P/Es.

For the purposes of this study, we have chosen toanalyze EBITDA multiples in the 12 broad industrygroups of our global sample.1 We have used EBITDAmultiples because they are the most stable measurefor a broad sample that includes many companieswith one or more years of abnormally low or negativeearnings. Because each industry group contains awide range of companies, the results tend to havelower empirical correlations (R2s) than do morefocused peer groups. Still, our analysis producedcorrelations between .65 and .92 (where an R2 of1.0 represents perfect correlation).2

1. Because of a lack of available data, we have conducted this analysis on U.S. companies only and included companies below the industry market-valua-tion hurdles used in our 596-company global sample.

2. The relative multiple analyses in this report are for illustrative purposes only and, in and of themselves, should not be construed as an adequate basisfor management action in any of the industries analyzed.

assuming, of course, that those actions are alignedwith their business strategy. Consider three typicalsituations:

Do No Harm. Given the importance of growth tolong-term shareholder value, many companieswith poor growth prospects seek to “break out” inorder to find new sources of growth. That’s a laud-able goal, but it turns out that expectations forgrowth are often a far less important driver of the

multiples for such companies than are other fac-tors that affect the quality, sustainability, and risklevel of current earnings. By understanding thedynamics that influence a company’s multiple,executives can anticipate the likely impact of cer-tain strategic moves and avoid unintended conse-quences.

Take, for example, the experience of one companywith a strong brand franchise and a long history of

33The Next Frontier

delivering modest but profitable organic growth.Senior executives at the company were concernedabout how they were going to maintain thecompany’s relatively high P/E. They assumed thatsustaining it required the company to grow farmore rapidly than it had in recent years.

Management was well down the road toward a newacquisition and a major geographic expansionwhen it discovered that these big strategic betswere precisely what its dominant investors did notwant. What the comparative multiple analysisshowed was that investors rewarded consistent low-risk earnings growth. Revenue growth was not akey driver of the multiple. Because executives hadtoo narrow a view of what really drove their multi-ple, the company’s initial plan ran the risk ofalienating its major investors—and thereby dam-aging its P/E multiple rather than improving it.Once they realized the true dynamics underlyingtheir P/E multiple, executives modified theircourse in order to pursue a less aggressive and lessrisky path to growth.

Credit Where Credit Is Due. In many situations,companies make genuine improvements in funda-mental value—only to fail to see these improve-ments translate into higher stock prices. Often,financial factors prevent them from getting creditfrom investors for performance improvements.

This was the recent experience of a major indus-trial-goods company in a capital-intensive industry.In terms of fundamental value, the company’s per-formance looked excellent. The company consis-tently delivered a higher return on capital em-ployed (ROCE) than its most direct competitor.And yet, for a decade, its multiple had been 25 percent below that of its chief rival. What ex-plained this valuation gap?

By analyzing the economic characteristics of thetwo companies and using comparative multipleanalysis to isolate the factors determining multi-ples for their entire peer group, managers wereable to identify and quantify four key sources ofthe gap. (See Exhibit 15.) For one thing, the com-pany's high ROCE was accompanied by above-aver-age volatility. As a result, value investors, who con-stituted the company’s dominant investor group,saw the stock as a relatively risky investment anddiscounted it accordingly.

Moreover, the company’s chief competitor was farmore disciplined in its use of free cash flow. Ourexample company was replacing its assets at a rate20 percent faster than that of its competitor—butwithout achieving enough productivity improve-ment to justify the investment. As a result,investors weren’t fully benefiting from the highROCE—whether in dividends returned to share-holders or in more cash to reinvest in profitablegrowth.

The company also had a much higher debt-to-cap-ital ratio than its competitor, which exacerbatedvolatility and added default risk. Finally, diversifi-cation gave the company an overly complex port-folio, which caused investors to discount the com-pany’s stock even more.

Once corporate executives realized the truesources of their relatively low multiple, they wereable to design a series of moves to address the keyproblems. The company reshaped its portfolio toincrease focus and minimize volatility (even at theprice of sacrificing some high-margin but rela-tively risky businesses). It used the proceeds from

E X H I B I T 1 5

QUANTIFYING THE SOURCE OF A VALUE GAP AT ANINDUSTRIAL GOODS COMPANY


NOTE: Numbers are for illustrative purposes only.

EBITDA multiple(x)

0

2

4

6

8

10

0

2

4

6

8

108.9

6.6

+0.5

+0.5+0.5

+0.8

Use of freecash flow

Company ROIvolatility

Debt-to-capitalratio

Portfoliocomplexity

Leadingpeer

34 BCG REPORT

Many of the best performers in our study enjoyunusually high valuation multiples. As a result, theyface the challenge of how to engineer a soft landing.Consider the case of the best-performing company inour entire 596-company global sample: Brazil’sEmpresa Brasileira de Aeronáutica, or Embraer.

The number four global aircraft manufacturer behindAirbus, Boeing, and Bombardier, with the equivalentof $5 billion in revenues, Embraer makes small andmidsize aircraft—turboprops and so-called regionaljets—for both civilian and military customers. Sincethe mid-1990s, Embraer has captured approxi-mately 40 percent of the booming regional-jet mar-ket, becoming one of the few emerging-market com-petitors in the aerospace industry. From 1999through 2003, the company racked up an extraordi-nary average annual TSR of 109 percent.

Embraer was able to achieve this remarkable featby using all the levers responsible for superior TSR

E N G I N E E R I N G A S O F T L A N D I N G

performance. As the two Embraer exhibits show,the company’s cash-flow margin, asset productiv-ity, and CFROI are all significantly above the aver-age of our industrial-goods industry sample andhave all improved modestly during the five-yearperiod of our study. But where Embraer really out-shone its rivals was in growth. The company’sasset-base growth was more than twice the indus-trial-goods industry average, and its sales growthmore than three times the average. This rapid salesgrowth, fueled by the increasing popularity of thecompany’s regional jets for short-haul air travel,was responsible for no less than 43 percentagepoints of Embraer ’s average annual TSR. Embraer ’sextraordinary performance has carried its EBITDAmultiple from significantly below average in 1998to above average in 2003. This improvement in itsmultiple relative to industry peers was responsiblefor an additional 44 percentage points of Embraer ’saverage annual TSR.

VALUE CREATION AT EMBRAER, 1999–2003 ( I )



’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

Total industrial goods industry sample, n = 67Embraer

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’030

5001,0001,5002,0002,5003,0003,5004,0004,500 3,963

1,6722,192

928

2,127

124134 1471091261004

24

44

64

84

40.1

22.5

6.916.8

25.9

74.5

47.2

7.37.78.17.27.70

5

10

15

20

25

30 25.5

9.6 8.7

18.116.3 16.7 17.2

25.2

10.08.98.8 9.4

–300

–200

–100

0

100

200

300

–40

–20

0

20

40

–68 –18

195253

123

–141

0

50

100

150

200

250

300

350

400

100

348

242

77

143

324

129121140135

110

100

0.0

1.0

2.0

3.0

4.0

5.0

1.61.2

1.9

4.3

1.61.0

0.80.80.80.80.9 0.8


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$millions $billions

35The Next Frontier

Looking to the future, it’s likely that Embraer willhave to ask itself three key questions. First, how longcan it sustain its remarkable growth? Second, arethere actions it should be taking today to anticipatethe time when this growth starts to slow, as it

inevitably will? And third, are there other ways forEmbraer to sustain its above-average multiple—forexample, by improving its cash-flow margins, whichare already well above the industrial-goods industryaverage?

VALUE CREATION AT EMBRAER, 1999–2003 ( I I )





Total industrial goods industry sample, n = 67Embraer

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

80130180230280330380430480530

100 102 112 117 119 127

418439

325

214

493

0

5

10

15

20

25

30

35

21.1 21.4

30.4

21.521.3

30.4

13.914.6 13.113.613.213.4

–10

0

10

20

30

40

50 43

3

44

0 2405

0

2

4

6

8

10

12

14

2.9

12.7

4.0

7.96.6

4.1

9.39.5

10.28.5

10.6

8.6

0

1

2

3

4

5

0.0 1.1

4.6

1.8

1.0

2.6

2.1

2.11.7

2.21.61.8

0500

1,0001,5002,0002,5003,0003,5004,0004,500

100

3,963

1,6722,192

928

2,127

124134 147109126

ƒ



Sales growth


EBITDA margin1



Salesgrowth

Marginchange

Multiplechange

Dividendyield

these divestitures to pay down debt. Finally, itrevised its capital-allocation process to lengtheninvestment cycles and depreciation periods.Within six months, these moves contributed toclosing the valuation gap, resulting in a 30 percentincrease—totaling about $2 billion—in the marketvalue of the company’s equity.

Living Up to High Expectations. A strong relativemultiple is a signal of strong investor confidencein a company’s future and can often serve as anadvantaged currency for acquisitions. But it also

poses a challenge—and sometimes even a threat.The fact is, in order to continue to generate supe-rior TSR, a company’s multiple needs to be sus-tainable—that is, a company has to be able todeliver on the expectations it generates.

One company, for instance, had such a highmultiple that executives believed they would have to generate substantial annual increases in profits over the next five years to fulfill theexpectations already embedded in the stock price. Unfortunately, existing company plans could

36 BCG REPORT

deliver at most half of the necessary earningsgrowth. How could executives close this value gap?

The comparative multiple analysis revealed that itwasn’t current earnings growth that really matteredso much as future earnings potential. And the crit-ical indicator to investors of that potential was thelevel of spending on R&D. Once they understoodthese dynamics, executives realized that they couldincrease R&D and create other new platforms forfuture growth, even though these investmentscame at the expense of near-term earnings growth.Although earnings growth declined somewhat, the

company avoided the collapse of its multiple. Thecompany continues to deliver TSR substantiallyabove the industry average.

In these situations, it is important to understandthat maximizing multiples, per se, is not necessar-ily the goal. Rather, executives need to understandhow various actions will affect the multiple andthen manage the tradeoffs between the multipleand other components of the overall TSR package.(For an example of how one of this year’s top per-formers may face this challenge, see the sidebar“Engineering a Soft Landing,” page 34.)

37

Prioritizing the Uses of Free Cash Flow

Improving a company’s fundamental value gener-ates cash. Companies face the choice either toreinvest that cash (through internal investmentsor acquisitions) or to distribute it to investors(through debt repayment, share buybacks, or divi-dends).

Distributing free cash flow has an impact that goesbeyond its direct contribution to TSR. For exam-ple, increasing free-cash-flow payout can also raisea company’s valuation multiple by reducing risk,adding credibility to the quality of the company’searnings, and signaling management’s commit-ment to value creation. What’s more, a meaningfulpayout of free cash flow can also serve as a disci-plining mechanism for a company’s fundamental-value engine—by creating competition for cashand pressure to improve profitability, and by mak-ing it likely that only the most promising invest-ment projects go forward.

For nearly two decades, most managers have seendistributions of free cash flow as a relatively unim-portant contributor to overall TSR. In the longbull market of the 1980s and 1990s, returning cashto investors, especially in the form of dividends,was particularly easy to dismiss. With average TSRrunning in the high teens, a dividend yield of even3 or 4 percent was a relatively minor contributor toabove-average TSR. And in a market environmentthat seemed to value growth exclusively, manymanagers believed that returning cash to investorsthrough dividends actually depressed TSR byundermining the expectations of investors, whooften saw such distributions as a de facto admis-sion that management had no growth agenda andcouldn’t find attractive ways to reinvest in thebusiness.

There are more and more signs, however, that thecombination of low dividend yields and highcapital gains that typified the 1980s and 1990s wasa historical anomaly, unlikely to reoccur anytimesoon. Over a longer time period, free cash flow hasbeen an extremely important component of TSR,

representing roughly 35 to 45 percent of the mar-ket-average TSR through dividend yield and sharerepurchase alone. In a market environment whereaverage returns are likely to be in the neighbor-hood of 7 to 9 percent, a 3 percent dividend yieldrepresents a substantial contribution to overallTSR, and for companies in low-growth industries,paying out dividends, or increasing them, can sig-nificantly reduce the revenue growth required todeliver superior TSR.

There are strong indications that investors todayview high-payout value-creation strategies muchmore favorably than they have in the recent past.In interviews with more than one hundred globalinstitutional investors, BCG has identified two par-allel trends. Increasingly, investors are favoringlow-risk value-creation strategies that producereturns modestly above the market average—asopposed to high-risk strategies characterized byaggressive growth aimed at top-quartile or betterperformance. At the same time, they are puttingrelatively more value on distributions of free cashflow as part of their lower-risk investment strategy.

This broad reevaluation of distributions of freecash flow is driven in part by the recent crisis ininvestor confidence as a result of the many gover-nance and accounting scandals of recent years.Unlike accounting measures such as earnings pershare, dividends are paid in cash. They can’t befaked. And once a company has committed to pay-ing them, they are almost never reduced. Thusthey send an unambiguous signal about real per-formance and management’s commitment toshareholder value. As one large-fund manager putit, “When I assess management’s confidence intheir business and their plans, I look first at thetrend in dividend payout.” What’s more, recentempirical research strongly suggests that higherpayout ratios do not necessarily reduce corporategrowth. In fact, companies with higher payoutratios have significantly higher long-term earningsgrowth rates than companies with lower payoutratios.18

The Next Frontier

18. See Robert D. Arnott and Clifford S. Asness, “Surprise! Higher Dividends = Higher Earnings Growth,” Financial Analysts Journal 59, no. 1 (January/February 2003), pp. 70–87; and Justin Lahart, “Fork It Over,” Ahead of the Tape, Wall Street Journal, July 23, 2004.

In some cases, a high-payout strategy can evenhelp a company achieve top-performer status.Take the example of the Swedish pulp-and-papercompany Holmen. From 1999 through 2003,Holmen racked up an average annual TSR of 22 percent—a full 13 percentage points above theindustry average—placing it at number six in thepulp-and-paper industry rankings. What’s more, itdid so despite the fact that its CFROI was flat dur-ing this period. (See Exhibit 16.)

How did Holmen do it? By providing a dividendyield significantly above the industry’s alreadyhigh average. In 1999, in 2000, and again in 2003,the company paid out a special dividend toinvestors, over and above its usual dividend. Alltold, Holmen’s dividend yield was responsible for16 percentage points of average annual TSR—more than two-thirds of the total. (See Exhibit 17.)

These trends imply that how a company decides touse its free cash flow isn’t just a tactical issue but

also an important strategic choice, one that canalign all the elements of a company’s value-creationstrategy. The decisions executives make about howto use free cash flow have profound implications forthe TSR aspirations they set and for the way theybalance short-term and long-term TSR.

In defining an appropriate payout strategy, execu-tives should ask two sets of questions. The firstconcerns the relative impact of free-cash-flow pay-out—versus reinvestment in the business—onshareholder value. For example, would a higherpayout compromise the company’s plans forfuture improvements in fundamental value? Ormight it serve as a useful discipline on thoseimprovements? How would a higher payout affecta company’s valuation multiple? What would ahigher-payout strategy deliver in terms of short-term and long-term TSR?

Another set of questions concerns the relative pri-orities for payouts of free cash flow. For instance,

38 BCG REPORT

E X H I B I T 1 6

VALUE CREATION AT HOLMEN, 1999–2003 ( I )



16.9

10.9

15.2

11.7 12.113.9

17.8

8.9

11.910.99.9 10.0

’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

Total pulp-and-paper industry sample, n = 29Holmen

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’030

50

100

150

200

250

300 273

233205215 215

136123153

124152

100

100

0

2

4

6

8

10

7.56.56.5

7.3

6.5

8.8

4.95.6

6.3

7.1

6.75.8

0

5

10

15

20

–100

–50

0

50

100

–25

–15

–5

15

25

517

80

29 18

–27 –27

0

20

40

60

80

100

120

140160

10091838084 89

132127143139

105100

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.4 0.4

0.50.5

0.60.6

0.6 0.6 0.6 0.60.6 0.6


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$millions $billions

is the company’s debt-to-capital ratio at an opti-mum level or should a significant portion of freecash flow go to paying down debt? What would bethe impact of increasing dividends on the com-pany’s valuation multiple? Would it make the com-pany’s stock more attractive to the types ofinvestors that the company wants to target? Is thecompany currently so undervalued that sharerepurchases would improve future TSR? (For a dis-cussion of share buybacks, see the sidebar “ShareBuybacks Versus Dividends,” page 40.) What sig-nals will different cash-distribution alternativessend to investors and analysts?

There are no universal answers to these questions.They depend on a variety of factors—the com-pany’s current level of CFROI, its opportunitiesfor profitable growth, whether its multiple is aboveor below the peer average, its existing (or desired)mix of investors, the risk profiles of the industry

and the company itself, and the aspirations of thesenior management team. Nevertheless, there arefive situations where a high-payout strategy maymake sense:

• When management’s aspiration is to consistentlydeliver TSR at or slightly above industry averages.Not all companies should aspire to top-quartilestatus. What’s more, not all investors expectthem to. Many fund managers are quite happywith TSR performance that is consistently two tothree percentage points above the market aver-age. In a market environment where averageTSR will likely be in the neighborhood of 7 to 9 percent, free-cash-flow distributions can makea major contribution to that goal.

• When the average CFROI of the operating businessunits is not significantly above the cost of capital. Acompany in this situation has yet to earn the

39The Next Frontier

E X H I B I T 1 7

VALUE CREATION AT HOLMEN, 1999–2003 ( I I )





Total pulp-and-paper industry sample, n = 29Holmen

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

0

50

100

150

200

250

300

100

273

233205215 215

136123153

124152

100

0

2040

60

80

100120

140

160

100

100

112131 132 135 137

707367

9071

68

101214161820222426

18.0

22.0

25.0

22.0

19.0

24.0

15.017.0

13.014.016.0

14.0

–10

–5

0

5

10

15

20

–7

7

24

16

3

–3

4

–2

6

0

2

4

6

8

10

12

4.7

6.85.3

6.7

8.5

5.4

7.96.9

9.68.28.6

8.1

0

15

30

45

3.36.5

28.3

4.3

41.0

3.54.33.1 4.12.8

5.1

2.6

ƒ



Sales growth


EBITDA margin1



Salesgrowth

Marginchange

Multiplechange

Sharechange

Dividendyield

40 BCG REPORT

In the 1980s and 1990s, share buybacks becamea popular way for some companies to distributecash to investors. By reducing the number ofshares outstanding, buybacks were a back-doormeans of improving earnings per share. And at atime when stock options were an increasinglyimportant component of senior executive compen-sation, buybacks also raised the value of managers’options (in a way that paying out dividends toinvestors did not).

Buybacks remain an advantaged way to distributefree cash flow when a company’s stock is clearlyundervalued, because they spread the same totalamount of future TSR over a smaller group ofremaining investors. However, many of the reasonsmanagers preferred buybacks to dividends in thepast are no longer valid.

• The perceived benefits to managers of usingshare buybacks to grow earnings per share havebeen overshadowed by the benefits of using divi-

S H A R E B U Y B A C K S V E R S U S D I V I D E N D S

dend payouts to demonstrate the quality and sus-tainability of earnings.

• Because many companies have announced buy-backs but failed to follow through on them, suchannouncements increasingly lack credibility withinvestors.

• As companies shift their incentive systems toemphasize restricted grants of stock (as opposedto stock options), the incentive to use buybacksto boost the value of options has declined.

• Changes in U.S. tax law have eliminated the pre-vious double taxation of dividends; the choicebetween buybacks and dividends is now tax neu-tral in the U.S. market.

• Finally, a number of BCG studies demonstratethat share buybacks have a neutral-to-negativeimpact on P/E multiples, whereas increases in div-idend payout have a consistently positive effect.

right to grow. Its first priority should be toimprove CFROI and profitability. Until the com-pany has achieved that goal, it should probablymaximize cash payout.

• When a company’s CFROI is above the underlyingorganic growth rate for its industry. Many compa-nies, especially in mature industries, find them-selves in a situation where they are generatingconsiderably more cash than they can invest inopportunities for profitable growth. These com-panies can deliver value without growth byreturning a substantial portion of the cash toinvestors.

• When a company’s valuation multiple is either low inabsolute terms or relatively low compared with indus-tr y peers. Many managers associate a high P/Eratio with high expected earnings growth. But alow P/E is often less a signal about the absenceof growth than a sign that investors are not will-ing to pay much even for current earnings.Investors may be concerned about the quality ofearnings, their sustainability, or the value ofreinvesting earnings in risky or low-return proj-ects. Whatever the reason, paying out more

earnings in dividends can be a way to signalmanagement’s conviction that the earnings arereal and sustainable, and to “force” a revaluationof current earnings as investors respond to thehigher dividend yield. (For an example of onecompany pursuing this strategy, see the sidebar“Using Free Cash Flow to Improve the ValuationMultiple.”)

• When a company’s dominant—or desired—investorsare value, income, or growth-at-reasonable-pricefunds. For these investors, dividend yield tendsto be a critical component of their investmentstrategy. If such investors are a dominant part ofthe investor base, or if attracting such investorsis an important part of a company’s value-cre-ation strategy, then dividends will be an impor-tant driver of TSR.

Finally, whatever conclusions executives reachabout how to use free cash flow, every companyneeds to have systems in place for how to manageit. Typically, companies have rigorous systems formanaging earnings. But they don’t have equiva-lent systems for managing free cash flow. Often,they lack explicit targets for free cash flow and

41

detailed processes for managing it day to day. Forexample, final approval for big-ticket capital-expenditure projects often occurs outside thenormal budgeting-and-planning process. Man-agement of capital expenditure and working capi-tal is not an explicit part of many incentivesystems. Improving working capital happens onlysporadically rather than consistently, year afteryear. And to the extent that management pro-cesses do focus on the generation of free cash flow,they often neglect its effective use. For all thesereasons, the generation and use of free cash flowremains an underexploited but increasinglyimportant lever at many companies.

As companies reconsider their priorities withregard to free cash flow, however, it’s important to

emphasize that any decisions must be put in thecontext of the company’s long-term business strat-egy. The choices a company makes about free cashflow have consequences for its competitive strategywithin its industry. Depending on the situation, acompany’s competitive position can be enhancedor eroded by decisions to pay out more cash. Insome cases, increasing distributions of free cashflow to investors serves as an important disciplineon line managers, causing them to avoid question-able investments that erode competitive position.But in other cases, increasing payout can reducethe cash available for investments necessary tokeep up with new technology or emerging growthopportunities. As with every decision about valuecreation, a company’s choices about free cash flowcannot be made in isolation.

The Next Frontier

For an illustrative example of how a company’s deci-sions about free cash flow can affect its multiple,take the example of the U.S. restaurant chain LoneStar Steakhouse. In early 2000, Lone Star was pay-ing no dividend and was trading at eight and a halftimes earnings. On April 13, the company an-nounced that it would start paying out almost half itsearnings as a dividend, creating a yield of 5.4 per-cent. Investors found this yield so attractive thatthey began buying the stock and bidding up its price.Over the next ten days, investors bid the company’s

U S I N G F R E E C A S H F L O W T O I M P R O V E T H E V A L U A T I O N M U L T I P L E

stock and P/E up by 18 percent to ten times earn-ings, driving the yield down to a more competitive4.6 percent. The short-term impact of the new divi-dend was to raise the company’s P/E multiple and toincrease TSR by 23 percent through a simple changein financial strategy. By 2004, Lone Star’s dividendpayout had increased to 51 percent of earnings, itsP/E ratio had increased from 10 to 19 (significantlyabove that of industry leader McDonald’s), and itsTSR was four times the market average during thisperiod.

THE RELATIONSHIP BETWEEN DIVIDEND YIELD AND P/E, LONE STAR STEAKHOUSE, APRIL 13–23, 2000


Yield (%)

0

2

4

6

8

10

1

1

2

3

2

3

0 5 10 15

46% payout

0% payout

P/E ratio (x)

Starting position• Low P/E (8.5)• Low payout (0%)• Low yield (0%)

Initial increase in dividend• Payout raised to 46%• Yield rises to 5.4%

Subsequent revaluation• Investors bid stock up 18% over 10 days, driving P/E up to 10 and yield down to 4.6%

In this year’s Value Creators report, we have madethe case for an integrated approach to value cre-ation, in which executives must manage the trade-offs among three key factors: fundamental value,valuation multiples, and distributions of free cashflow. But how does a company get started? Thereare five basic steps in designing and implementingan integrated value-creation strategy.

Step One: Know Your Starting Point. The first stepis to develop a comprehensive fact base to informthe senior management debate. Companies shouldaim to develop detailed quantitative and qualitativedata in at least five areas:

• Historical TSR. Break down the sources of your his-torical value creation. What has been the evolutionof your underlying fundamentals, investor expec-tations, and free cash flow?

• Current Company Plans. Take a hard look at whatyour current business plans will deliver. What kindof TSR are you likely to achieve if you deliver onthese plans? Are the plans really defensible givenyour internal capabilities and the likely responsesof competitors?

• Industry Trends. Broaden your analysis to includethe basic economic and competitive trends drivingvalue creation in your industry. How have the topperformers in your industry succeeded in the past?What are likely to be the most important drivers ofvalue creation in the future?

• Capital-Market Dynamics. Understand how the capi-tal markets put a value on performance in yourindustry. What explains the variations in valuationmultiples among your closest competitors? Wheredoes your company stand relative to peers and why?

• Investor Mix. Engage with your dominant investorsin a rich two-way dialogue. Who owns your sharesand what are their priorities? Are your currentplans in sync with their investment style? Do exist-ing or desired investors find your plans credible?

Companies need to integrate investors’ perspectivesand capital-market dynamics with more traditionalinternal and industry viewpoints. When they do,they typically discover that savvy investors havestrong—and often illuminating—views on all of theabove questions. But it’s important to rememberthat becoming more knowledgeable about whatinvestors really want doesn’t mean letting themdetermine your business strategy—any more thanlearning about what customers really want meansletting them determine your product strategy.Rather, the goal is to ensure that a company’s strat-egy is informed by the perspectives and require-ments of its investor base, and then to work overtime to create alignment between strategy andshareholders.19

Step Two: Select an Appropriate TSR Target. Oncea senior executive team has assembled a compre-hensive fact base, it is in a position to establish anappropriate TSR target for the future. That’s notsimply a matter of choosing an aggressive goal—forexample, top-quartile status in the company’s peergroup. By definition, relatively few companies willmeet that hurdle and even fewer will achieve it con-sistently year after year. Setting the right target ismore a matter of developing a healthy balancebetween stretch goals and goals that are consis-tently achievable. The challenge is to define a gameplan that excites current and potential investorsand that motivates the organization to be the best itcan be.

One effective approach is to craft two or three com-peting scenarios for TSR performance and thor-oughly debate them. For example, contrast a low-risk strategy designed to deliver modestlyabove-average TSR over the long term with a moreaggressive strategy designed to achieve top-quartilestatus or higher in the near term. Should the busi-ness go for aggressive growth, or should it becomea machine for generating free cash flow? Shouldthe company maximize near-term P/E? EPSgrowth? Return on capital employed? CFROI?

Five Steps for Building an Integrated Value-Creation Strategy

42 BCG REPORT

19. See “Treating Investors Like Customers,” BCG Perspectives, June 2002.

In exploring the key choices, it’s important toremember that sometimes what look like hard-and-fast tradeoffs at first glance may, on closer exami-nation, turn out to be unnecessary compromiseswaiting to be broken. In some situations, for exam-ple, paying out more cash to investors may be thebest way to discipline the organization to invest inonly the most promising—and profitable—growthopportunities. The result may be both a higheryield and equal or even higher profitable growth.

The purpose of debating such scenarios is to getsenior managers to articulate their priorities andbeliefs. Do they really believe that the organizationcan achieve top-quartile TSR in the next three tofive years? Or is it more likely to achieve TSR that isconsistently two to three percentage points abovethe peer-group average for the next decade? Whereyou finally end up is less important than consider-ing all the alternatives and having a rigorous

debate. The goal is to develop a target and a set ofself-reinforcing actions for achieving it that theentire team understands and is willing to endorse.

Step Three: Develop a Plan to Fill the Value Gaps.This target-setting exercise will identify gapsbetween senior management’s aspirations for TSRperformance and what the company’s currentplans purport to deliver. In some cases, plans mayappear to meet the goal, but executives are notconfident that the organization can really deliver.In other cases, the plans will actually fall short ofthe TSR goal. Although this is sometimes merely asign of a healthy tension between existing plansand achievable stretch goals, it is often a signalthat the company needs to expand its value-cre-ation opportunity set.

Changes in financial strategy can be a near-termopportunity to narrow the gap. For example,

43The Next Frontier

1. What fundamental value will your current plansgenerate? Is that performance really defensiblegiven the competitive dynamics of your industry?Is it enough to meet your TSR aspirations?

2. What are the market expectations embedded inyour stock price? Is there a gap between whatyou can deliver and what investors expect? If so,do you have a plan for closing it?

3. What drives valuation multiples in your indus-try? Why is your multiple at its current level rela-tive to industry peers?

4. What are the key tradeoffs between improvingfundamental value, optimizing your valuationmultiple, and distributing free cash flow? Do youhave a plan for managing these tradeoffs?

5. Who are the dominant investors in your com-pany and what are their priorities? Are yourplans in sync with their investment goals? Dothey find your value-creation strategy credible?

6. What is an appropriate TSR target given yourcompany’s situation? Does your managementteam understand and own it?

Q U E S T I O N S E V E R Y C E O S H O U L D K N O W H O W T O A N S W E R

7. How will you close the gap between the TSRyour current plans are likely to generate andthe TSR targets that you have set? What are theimplications for your business strategy andfinancial strategy?

8. What are the consequences of your company’svalue-creation strategy for line managers andtheir business units? Do they know what theymust deliver to achieve your TSR target? Have youtranslated that target into operational metrics andgoals that line managers can actually influence?Are they genuinely committed to reaching thesegoals?

9. Are management processes such as planning andbudgeting, resource allocation, and incentivecompensation aligned with your value-creationstrategy? Do they surface the right tradeoffs formanagement discussion? Do they appropriatelybalance short-term and long-term priorities?

10. Do you have a process in place for revisitingthe company’s value-creation strategy as eco-nomic conditions and the company’s situationchange? Have you established explicit triggersfor activating that process?

reducing a company’s debt-to-capital ratio canlower the cost of capital, improve P/E, and offer astronger appeal to more risk-averse investors. Andincreasing dividend payout not only raises yield,sometimes it can also improve P/E and creategreater internal discipline, forcing managers tofree up cash from working capital or underper-forming fixed assets.

But closing a significant value gap usually meansthat a company has to find new ways to create morefundamental value—with implications for competi-tive strategy. For example, will meeting your TSRtargets require more growth? If so, where will thatgrowth come from—how much from internalinvestments in organic growth, how much fromacquisitions? What are the key priorities and trade-offs you need to manage—between growth andmargins, between a plan to improve fundamentalvalue and its likely impact on your valuation multi-ple or on free-cash-flow yield?

Sometimes, of course, the conclusion will be thatthere is no easy way to close the gap. In such a situ-ation, managers confront the unwelcome choice ofeither revising their TSR targets downward or con-sidering fundamental changes in their businessportfolio. Depending on the circumstances, eithermove may be the right thing to do, but a companyshould choose neither until it has thoroughlyassessed all other possible actions to close the gap.

Step Four: Translate Your Value-Creation Strategyinto Concrete Operational Priorities. Part of thechallenge in step four is communication—makingsure all key corporate and business unit executivesunderstand the strategy and know what its implica-tions are for their areas of responsibility. Do linemanagers have a clear view of the priorities for theirbusiness units? Do they understand what levers ofvalue creation they are responsible for? Do theyknow what the company’s financial strategy willmean for their use of capital?

But the biggest challenge is to translate high-levelTSR goals into operational metrics and targets thatmanagers can actually influence. Can you get whereyou need to go by using your existing metrics—

operating income, say, or return on invested capi-tal? Or do you need to introduce a set of more for-mal value-management metrics—say, cash flowreturn on investment, total business return, or cashvalue-added? Whatever set of metrics you choose,make sure to incorporate them in supportingprocesses such as planning and budgeting, resourceallocation, investor communication, financial poli-cies, and management incentives.20

Step Five: Revisit the Strategy Often. Even when acompany has done the hard work of designing andimplementing an integrated value-creation strategy,executives often find that they must frequently revisittheir assumptions and priorities. Circumstanceschange. A company’s starting point evolves continu-ously over time. In any given company, the require-ments for superior TSR performance vary over time.At times, near-term growth will be critical; at othertimes, traditional sources of growth will be exhaustedand a company will have to shift its focus to prof-itability and free cash flow in order to regroup andbuild the next growth platform. The key is knowingwhere you, your industry, and your investor mix arein the cycle at any moment in time, and what youneed to do in order to shift the balance among thethree dimensions of value creation. Being preparedto adapt strategy to a changing situation will enablea company to anticipate what drivers will be mostimportant in the future and so avoid the commonmistake of becoming trapped by legacy value-cre-ation priorities that are no longer relevant.

Only when they have taken these five steps canexecutives really be confident that their companyhas an integrated value-creation strategy. Executivesoften find not only that they can take advantage ofthe full range of levers for generating TSR but alsothat they have created a powerful language withwhich to raise the quality of the strategic debateabout value creation—between the senior team andthe company’s board, between corporate and linemanagement, between the company and itsinvestors. Building an integrated value-creationstrategy is the best way to keep pace with the chal-lenges—and the opportunities—of today’s muchtougher stock-market environment.

44 BCG REPORT

20. See “When Culture Undermines Vision,” BCG Perspectives, July 1999; and “New Directions in Value Management,” BCG Perspectives, November 2002.

45

Methodology

The 2004 Value Creators study is based on theanalysis of total shareholder return at 596 globalcompanies for the five-year period from 1999through 2003.

To arrive at this sample, we began with returns datafor some 5,000 companies provided by ThomsonFinancial Worldscope. We eliminated all companiesthat were not listed on some world stock exchangefor the full five years of our study or did not have atleast 25 percent of their shares available on publiccapital markets. We also eliminated certain indus-tries from our sample—for example, financial serv-ices.21 Finally, we further refined the sample byorganizing the remaining companies into 12 in-dustry groups and establishing an appropriatemarket-valuation hurdle to eliminate the smallestcompanies in each industry. (The size of the market-valuation hurdle for each individual industry can befound in the tables in “The 2004 Industry Rankings,”beginning on page 61.) The resulting 596-companysample is used for most of the analyses in the report.

We also applied one more filter to our sample toidentify the best-performing large global compa-nies: a market-valuation hurdle of $20 billion. Thisgave us 142 large-cap companies. In addition to our596-company sample, we have also included rank-ings for the large-cap top ten in “The 2004 GlobalRankings,” pages 46–51, and many of these compa-nies serve as case studies in the report itself.

The global, regional, and industry rankings arebased on five-year TSR performance from 1999through 2003.22 We also show TSR performance for2004, through October 13. In addition, we breakdown TSR performance into key operational andfinancial metrics. First, for every company andindustry, we calculate the growth (or decline) infundamental value and in expectation premiumsfor the five-year period from 1999 to 2003. Second,we break down TSR performance into the six in-vestor-oriented financial metrics described on pages12–13. Both analyses can be found in the rankings.

Finally, at a number of points in the report, we haveincluded analyses of other samples where the lack ofavailable data made it difficult to analyze our globalsample. For example, we show historical data onexpectation premiums at selected companies of theU.S. S&P 400. We limit our comparative multipleanalysis to selected U.S. companies in our 12 indus-tries, including some below the industry-specificmarket-valuation hurdles used in our 596-companysample. And we cite recent BCG research comparingthe stock-market performance of 705 public U.S.companies for the ten-year period 1993–2002 basedon their level of M&A activity. Finally, in one case(page 20), we analyze 1,727 global companies with a2003 market valuation of more than $1 billion andfor which we have ten-year TSR data, in order to seehow many years each company has exceeded its localmarket average.

The Next Frontier

21. We chose to exclude financial services because measuring value creation in the sector poses unique analytical problems that make it difficult to com-pare the performance of financial-services companies with that of companies in other sectors. For BCG’s view of value creation in financial services, seeThe Path to Value Creation: Global Corporate Banking 2003, BCG report, November 2003.

22. TSR is a dynamic ratio that includes price gains and dividend payments for a specific stock during a given period of time. To measure performancefrom 1999 through 2003, 1998 end-of-year data must be used as a starting point in order to capture the change from 1998 to 1999, which drives 1999TSR. For this reason, all exhibits in the report showing 1999–2003 performance begin with a 1998 data point.

0

100

200

300

400

500

–60 –40 –20 0 20 40 60 80 100 120


First quartile

Second quartile

Third quartile

Fourth quartile

n = 596

20.4

9.0

2.1

–6.8

Number of companies


TSR (%)

EmbraerDenwayMotors

Votorantim Celulose

AracruzCelulose

LaboratoryCorporation

ImpalaPlatinum

NOK

Qualcomm

Symantec

Samsung Electronics

TSR Decomposition1

1 EMBRAER BRAZIL INDUSTRIAL GOODS 108.7 5.841 59 43 0 44 3 –4 22 –26.8

2 DENWAY MOTORS HONG KONG AUTOMOTIVE 87.8 3.728 84 20 –32 102 2 –19 15 –29.8

3 VOTORANTIM CELULOSE BRAZIL PULP AND PAPER 74.2 1.088 –16 38 14 12 4 –1 6 11.4

4 ARACRUZ CELULOSE BRAZIL PULP AND PAPER 69.6 3.133 35 52 0 0 7 0 10 6.8

5 LABORATORY CORP UNITED STATES PHARMACEUTICALS 60.8 5.287 2 13 12 8 0 –19 47 16.2

6 IMPALA PLATINUM SOUTH AFRICA INDUSTRIAL GOODS 56.4 5.786 35 31 11 8 8 –1 –1 5.1

7 NOK JAPAN AUTOMOTIVE 53.3 6.133 69 5 6 31 2 0 9 7.9

8 QUALCOMM UNITED STATES TECHNOLOGY 53.0 43.148 50 4 32 18 0 –6 5 53.5

9 SYMANTEC UNITED STATES TECHNOLOGY 44.7 10.628 45 23 18 10 0 –5 –1 61.5

10 SAMSUNG ELECTRONICS SOUTH KOREA TECHNOLOGY 44.2 61.926 40 21 –3 10 3 –3 15 –0.1

Market Expect. Sales Margin Multiple Dividend Share Net debt 2004 TSR2 value3 premium4 growth change change5 yield change change TSR6

# Company Country Industry (%) ($billions) (%) (%) (%) (%) (%) (%) (%) (%)

Total Industry

46 BCG REPORT

The 2004 Global Rankings

THE GLOBAL TOP TEN, 1999–2003


1Contribution of each factor is shown in percentage points of five-year average annual TSR.

2Average annual total shareholder return, 1999–2003.

3As of December 31, 2003.

4Expectation premium as percentage of total 2003 market value.

5Change in EBITDA multiple.

6As of October 13, 2004.



NOTE: TSR derived from calendar year data; values shown for top ten companies only.

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

56

399

16.9

9.69.2

15.1

19.0

9.6

13.2 13.5

10.19.7

11.9

9.7

1.1 1.11.0

1.1

1.3

1.1

0.70.70.70.8

0.90.8

0100200300400500600700800900

1,000

720

482508

906

466

107122 10283140

100

100 0

5

10

15

20

25

18.4

15.2

7.2

12.5

19.8 20.5

13.9

7.27.17.78.07.9

5

10

15

20

–2

–1

0

1

2

–300

–200

–100

0

100

200

300

0

50

100

150

200

250

100

217

171154

99

201

145134150145

112

100

0.4

0.6

0.8

1.0

1.2

1.4

Total shareholder return Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total sample, n = 596Top ten

Cash value-added1

Total global sample Top decile Global top ten

n = 596 n = 60 n = 10

’98 ’03 ’042 ’98 ’03 ’042 ’03 ’042

Value index1 Value index1 Value index1

0

100

200

300

400

500

600

0

100

200

300

400

500

600

’980

100

200

300

400

500

600

100118 119

43%

57%80%

20%

81%

19%–11%/year

11%/year

36%/year

20%/year100

299 319

75%

25% 62%

38%

62%

38%

92%/year

28%/year100

544

637

57%

43%

91%

9% 51%

49%



1Top-ten values (bars) correspond to left axis; industry sample values correspond to right axis.




47The Next Frontier

CHANGE IN FUNDAMENTAL VALUE AND EXPECTATION PREMIUMS, 1999–2003

VALUE CREATION AT THE TOP TEN VERSUS GLOBAL SAMPLE, 1999–2003 ( I )

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

5.3

9.910.6

12.214.6

9.2

11.5

8.4

10.3

6.9

18.3

11.6 1.8

3.2

1.9

2.0

2.7 2.52.4

2.0

2.7

1.6

2.1

1.1

14.9

19.819.7

16.015.4

23.7

15.1

27.4

15.715.3

23.8

17.2

’98 ’99 ’00 ’01 ’02 ’030

100200300400500600700800900

1,000

720

482508

906

466

107122 10283140100

100 80

100120

140160

180200

220

240

100

100 107119 124 125 130

232

170157

123

208

81012141618202224262830

21

3

17

3 2

–3

1

6

–5

0

5

10

15

20

25

56789

10111213141516171819

0

1

2

3

4

ƒ

Total sample, n = 596Global top ten



Sales growth


EBITDA margin1







48 BCG REPORT

VALUE CREATION AT TOP TEN VERSUS GLOBAL SAMPLE, 1999–2003 ( I I )

49The Next Frontier

0

36

72

108

142

–30 –20 –10 0 10 20 30 40 50 60


First quartile

Second quartile

Third quartile

Fourth quartile

n = 142

16.4

5.3

–0.9

–7.5

Number of companies


TSR (%)

ForestLaboratories

Samsung Electronics

QualcommNissan Motor

eBaySysco

BHP Billiton

Boston Scientific3M

Rio Tinto



3 FOREST LABORATORIES UNITED STATES PHARMACEUTICALS 36.0 22.596 37 37 21 –19 0 –3 0 –24.2

4 NISSAN MOTOR JAPAN AUTOMOTIVE 29.8 51.632 20 1 12 0 1 –10 26 0.7

5 EBAY UNITED STATES CONSUMER GOODS 26.3 41.737 78 69 10 –48 0 –7 0 45.1

6 SYSCO UNITED STATES CONSUMER GOODS 23.6 24.093 62 12 4 4 2 1 1 –18.0

7 BOSTON SCIENTIFIC UNITED STATES PHARMACEUTICALS 22.4 30.112 65 10 1 9 0 –1 3 2.6

8 3M UNITED STATES MULTIBUSINESS 21.7 66.579 59 4 3 9 3 1 2 –5.6

9 RIO TINTO UNITED KINGDOM INDUSTRIAL GOODS 21.7 29.385 24 6 11 0 5 0 0 2.0

10 BHP BILLITON AUSTRALIA INDUSTRIAL GOODS 21.1 34.482 25 –6 25 22 3 –21 –2 24.9

TSR Decomposition1



Large-Cap

THE LARGE-CAP TOP TEN, 1999–2003


NOTE: n = 142 global companies with market valuation greater than $20 billion. 1Contribution of each factor is shown in percentage points of five-year average annual TSR.2Average annual total shareholder return, 1999–2003.3As of December 31, 2003.4Expectation premium as percentage of total 2003 market value.5Change in EBITDA multiple.6As of October 13, 2004.



NOTE: TSR derived from calendar year data.

50 BCG REPORT

100

313

202179

207 222

1071239981

145100

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

$billions $billions

’98 ’99 ’00 ’01 ’02 ’03

12.4

11.5

9.4

11.2

11.5

10.4

11.011.611.6

9.8

10.711.4

0.8

0.9

0.8

0.9

1.01.0

0.70.70.70.7

0.8 0.8

10.3 10.2

7.7

8.910.2 10.5

8.6

7.67.38.28.88.7

–300

–200

–100

0

100

200

300

0

50

100

150

200

250

300

350

0

2

4

6

8

10

12

8

9

10

11

12

13

14

–6

–3

0

3

6

020406080

100120140160180

100

149129

11796

143

160144

167161

114100

0

0.5

0.6

0.7

0.8

0.9

1.0

1.1

Total sample, n = 142Large-cap top ten


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

Total large-cap sample Large-cap top ten


248

56%

44%

100

69%

31%

100119

48%

52%

277

53%

47%

Valueindex1

Valueindex1

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

83%

118

86%

14%17%

28%/year

15%/year

–16%/year

14%/year

0

50

100

150

200

250

300

0

50

100

150

200

250

300

n = 142 n = 10







VALUE CREATION AT TOP TEN VERSUS GLOBAL SAMPLE, 1999–2003 ( I )

51The Next Frontier

100

100

111

126131 133

137

140

113113106

125

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

7.8

10.4

12.0

13.7

11.39.9

12.7

8.9

12.0

9.7

16.5

12.71.6

2.3

1.3

1.5

2.3

1.41.7

1.1

1.71.4

1.61.5

’98 ’99 ’00 ’01 ’02 ’030

50

100

150

200

250

300

350

100

313

202179

207 222

107123 9981

145

100

80

90

100

110

120

130

140

150

14

16

18

20

15.9

19.1

17.818.8

17.0

19.5

16.4

19.0

18.718.4

18.418.2

–12

–7

–2

3

8

13

18

8

2

10

42

–3

1

7

56789

101112131415161718

0

1

2

3

ƒƒ



Sales growth


EBITDA margin1



Total sample, n = 142Large-cap top ten





VALUE CREATION AT TOP TEN VERSUS GLOBAL SAMPLE, 1999–2003 ( I I )

52 BCG REPORT


First quartile

Second quartile

Third quartile

Fourth quartile

n = 56

16.4

6.8

–0.1

–6.0

Number of companies


TSR (%)

0

14

28

42

56

–20 –10 0 10 20 30 40 50

Posco

Reliance Industries

Nissan MotorSK Telecom

BHP BillitonTaiwan Semiconductor

Canon

RicohTokyo Electron

Samsung Electronics

Asia-Pacific




The 2004 Regional Rankings

TSR Decomposition1




2 RELIANCE INDUSTRIES INDIA CHEMICALS 38.6 17.537 44 35 –6 9 3 –8 6 –5.0

3 NISSAN MOTOR JAPAN AUTOMOTIVE 29.8 51.632 20 1 12 0 1 –10 26 0.7

4 SK TELECOM SOUTH KOREA TECHNOLOGY 28.2 13.742 18 24 3 1 1 –2 1 –8.8

5 POSCO SOUTH KOREA INDUSTRIAL GOODS 24.1 12.171 –26 6 4 –3 4 3 10 13.4

6 BHP BILLITON AUSTRALIA INDUSTRIAL GOODS 21.1 34.482 25 –6 25 22 3 –21 –2 24.9

7 TAIWAN SEMICONDUCTOR TAIWAN TECHNOLOGY 18.6 37.907 68 30 1 –9 0 –5 2 –22.5

8 CANON JAPAN TECHNOLOGY 16.4 41.035 1 3 6 2 1 0 5 7.1

9 RICOH CO JAPAN TECHNOLOGY 16.0 14.701 34 5 2 3 1 –1 6 4.3

10 TOKYO ELECTRON JAPAN TECHNOLOGY 13.9 13.718 75 0 –17 30 0 0 0 –30.6

THE ASIA-PACIFIC TOP TEN, 1999–2003



53The Next Frontier

Total sample, n = 56Asia-Pacific top ten

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

13.1

9.68.3

10.0

12.0

9.5

11.1

12.7

9.48.7

9.6

9.2

0.8 0.80.8

0.90.90.9

0.7 0.7 0.7 0.7 0.7 0.7

10.2

6.2

8.6 9.210.3

8.6

6.06.26.46.26.2

–300

–200

–100

0

100

200

300

–6

–3

0

3

6

0

50

100

150

200

250

300

350

100

306

239

185

229 230

116132

11397

203

100

0

2

4

6

8

10

12 10.6

8

9

10

11

12

13

14

020406080

100120140160

100

150131

116

99

144

119109

126123103

100

0.4

0.5

0.6

0.7

0.8

0.9

1.0


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total regional sample Asia-Pacific top ten


100

19%

113 115

99%81%

99%

Valueindex1

Valueindex1

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

n = 56 n = 10

1% 1%–42%/year

7%/year

0

50

100

150

200

250

100

16%

206 207

70%

84%

72%

28%30%31%/year

12%/year

0

50

100

150

200

250







VALUE CREATION AT TOP TEN VERSUS REGIONAL SAMPLE, 1999–2003 ( I )

54 BCG REPORT

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

6.17.5

9.29.6

9.4 7.78.8

6.3

7.7

6.8

14.8

8.5 1.4

2.5

1.4

0.8

2.2

1.6

3.8

0.9 1.61.1

1.51.1

80

90100

110120

130140

150

160

100

100 99 101107 110 111

155

125118

109

141

12

14

16

18

20

13.6 14.0

18.0

16.5

19.3 18.9

15.414.414.814.9

13.713.4

–4–202468

1012

9

57

–2

21

32

56789

10111213141516

0

1

2

3

4

’98 ’99 ’00 ’01 ’02 ’030

50

100

150

200

250

300

350

100

306

239

185

229 230

116132

11397

203

100

ƒ




Sales growth


EBITDA margin1







VALUE CREATION AT TOP TEN VERSUS REGIONAL SAMPLE, 1999–2003 ( I I )

55The Next Frontier


First quartile

Second quartile

Third quartile

Fourth quartile

n = 81

13.4

5.0

–3.0

–12.0

Number of companies


TSR (%)

0

21

42

63

84

–30 –20 –10 0 10 20 30

STMicroelectronics

Rio TintoPorsche

Siemens

CentricaBritish AmericanTobacco

Imperial Tobacco

Christian DiorPeugeot

LVMH

Europe




TSR Decomposition1



1 RIO TINTO UNITED KINGDOM INDUSTRIAL GOODS 21.7 29.385 24 6 11 0 5 0 0 2.0

2 PORSCHE GERMANY AUTOMOTIVE 20.9 10.353 –5 17 12 –10 2 0 0 13.2

3 IMPERIAL TOBACCO UNITED KINGDOM CONSUMER GOODS 20.0 14.321 –3 26 –5 –3 4 –3 0 16.3

4 CHRISTIAN DIOR FRANCE CONSUMER GOODS 18.4 11.010 –20 11 2 –15 3 0 17 7.3

5 PEUGEOT FRANCE AUTOMOTIVE 16.1 12.389 –2 10 –5 1 3 5 2 28.6

6 LVMH FRANCE CONSUMER GOODS 15.7 35.658 40 12 3 –2 3 0 1 –0.1

7 BRIT. AMERICAN TOBACCO UNITED KINGDOM CONSUMER GOODS 15.4 28.677 6 8 6 –1 8 –6 –1 9.5

8 STMICROELECTRONICS FRANCE TECHNOLOGY 14.1 24.435 57 11 –2 5 0 –1 0 –33.7

9 CENTRICA UNITED KINGDOM UTILITIES 13.7 16.070 –15 18 5 –13 5 1 –1 18.9

10 SIEMENS GERMANY MULTIBUSINESS 13.5 71.692 24 4 –1 5 2 0 3 –2.1

THE EUROPEAN TOP TEN, 1999–2003



56 BCG REPORT

Total sample, n = 81European top ten

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

10.3

7.9

6.7

9.6 9.5

6.8

9.1

10.8

9.0

7.7

9.1

7.8

1.1 1.1 1.1 1.11.0

1.1

0.70.70.7

0.80.9

0.8

8.8

7.8

8.2 8.0

9.7

7.2

7.56.3

7.17.9

7.0

–6

–3

0

3

6

100

100

8.4

100

100

0

50

100

150

200

250 217194209221

168

111136

9278

149

0

2

4

6

8

10

12

4

6

8

10

12

–100

–50

0

50

100

0

50

100

150

200

152152133

115

146

187163 173177

127

0.40.5

0.60.7

0.80.9

1.01.1

1.2


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total regional sample European top ten


100

65%

121

–1%

35%

125

Valueindex1

Valueindex1

’98 ’99 ’00 ’01 ’02 ’03 ’042

100%101%13%/year

n = 81

–50

0

50

100

150

200

100

80%

175

16%

20%

181

21%

’98 ’99 ’00 ’01 ’02 ’03 ’042

79%84%

13%/year

8%/year

n = 10

–50

0

50

100

150

200







VALUE CREATION AT TOP TEN VERSUS GLOBAL SAMPLE, 1999–2003 ( I )

57The Next Frontier

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

8.0 8.48.8

12.6

11.8

7.8

10.8

9.18.0

7.9

13.6

10.22.9

4.3

2.7

2.2

3.9

2.73.1

2.1

3.6

2.0

2.92.4

100

10015.3 15.4

20.121.6

22.3

19.4

17.516.3

15.215.6

19.5 19.7

’98 ’99 ’00 ’01 ’02 ’03

100

100

0

50

100

150

200

250 217194

209221

168

111136

9278

149

8090

100110120130140150160170180

114

135144 142 138

174166

143

116

172

12

14

16

18

20

22

24

–12

–7

–2

3

8

13

1813

41

–4

033

8

56789

101112131415

0

1

2

3

4

5

Total sample, n = 81European top ten

ƒ



Sales growth


EBITDA margin1








58 BCG REPORT


First quartile

Second quartile

Third quartile

Fourth quartile

n = 105

Number of companies


TSR (%)

18.8

7.6

0.9

–6.3

0

27

54

81

108

–30 –20 10 0 10 20 30 40 50 60

Veritas Software

Qualcomm

Forest Laboratories

eBayStryker

3M

Analog Devices

SyscoBoston Scientific

Newmont Mining

North America




TSR Decomposition1




2 FOREST LABORATORIES UNITED STATES PHARMACEUTICALS 36.0 22.596 37 37 21 –19 0 –3 0 –24.2

3 EBAY UNITED STATES RETAIL 26.3 41.737 78 69 10 –48 0 –7 0 45.1

4 STRYKER UNITED STATES PHARMACEUTICALS 25.5 16.958 29 27 2 –7 0 –1 5 5.0

5 ANALOG DEVICES UNITED STATES TECHNOLOGY 23.8 16.973 69 11 3 9 0 –3 3 –15.6

6 SYSCO UNITED STATES CONSUMER GOODS 23.6 24.093 62 12 4 4 2 1 1 –18.0

7 VERITAS SOFTWARE UNITED STATES TECHNOLOGY 22.7 15.829 61 47 3 –13 0 –14 1 –44.3

8 BOSTON SCIENTIFIC UNITED STATES PHARMACEUTICALS 22.4 30.112 65 10 1 9 0 –1 3 2.6

9 NEWMONT MINING UNITED STATES INDUSTRIAL GOODS 22.3 17.801 43 16 0 16 1 –18 7 –5.3

10 3M UNITED STATES MULTIBUSINESS 21.7 66.579 59 4 3 9 3 1 2 –5.6

THE NORTH AMERICAN TOP TEN, 1999–2003



59The Next Frontier

Total sample, n = 105North American top ten

–100

–50

50

100

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

11.9

10.7

9.6

12.1

12.9

11.0

11.6

12.7

12.5

10.5

11.5

11.2

1.1 1.11.21.2

1.11.1

0.70.70.80.8

0.9 0.9

12.7

7.9

10.911.9

14.6 13.5

8.38.89.810.810.4100

100

14.5

100

100

0

50

100

150

200

250

300

350287

191181156

191

110109 10587120

0

5

10

15

20

8

9

10

11

12

13

14

–3

–2

–1

0

1

2

3

0

0

50

100

150

200

163

121122114

150

155151175

160

114

0.4

0.6

0.8

1.0

1.2

1.4


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total regional sample North American top ten


100118 115

100

330

71%44%

77%

37%

43%

57%

358

43%

57%

63%

29%

56%

23%

Valueindex1

Valueindex1

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

14%/year

–10%/year

31%/year

25%/year

0

50

100

150

200

250

300

350

0

50

100

150

200

250

300

350

n = 105 n = 10







VALUE CREATION AT TOP TEN VERSUS REGIONAL SAMPLE, 1999–2003 ( I )

60 BCG REPORT

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Sales

growthMarginchange

Multiplechange

Dividendyield

16.5

12.9

14.8

16.4

17.416.0

18.3

14.4

19.1

12.0

17.6

13.41.0

1.3

0.8

0.5

0.8 0.81.0

0.30.50.40.50.4

100

100 14.4 14.6

19.720.3 20.1

19.0

16.515.4

14.1

15.9

18.6 18.6

–12

–7

–2

3

8

13

18

10

01

–7

12

10

8

8090

100110120130140150160170

111

128

133 137149

159

133

126113

139

12

14

16

18

20

22

56789

1011121314151617181920

0

1

2

’98 ’99 ’00 ’01 ’02 ’03

100

100

0

50

100

150

200

250

300

350287

191181156

191

110109 10587120


ƒ



Sales growth


EBITDA margin1









First quartile

Second quartile

Third quartile

Fourth quartile

n = 42

Number of companies


TSR (%)

30.3

10.7

4.2

–7.6

0

11

22

33

44

–40 –20 0 20 40 60 80 100

Denway MotorsNOKToyoda Gosei

PaccarHyundai Motor

Nissan Motor

Tata Motors

PorscheGentex

Stanley Electric

61The Next Frontier

Automotive and Supply

The 2004 Industry Rankings




TSR Decomposition1

1 DENWAY MOTORS HONG KONG 87.8 3.728 84 20 –32 102 2 –19 15 –29.8

2 NOK JAPAN 53.3 6.133 69 5 6 31 2 0 9 –7.9

3 STANLEY ELECTRIC JAPAN 42.4 3.645 46 4 11 24 2 0 0 –25.5

4 TOYODA GOSEI JAPAN 40.0 3.590 48 5 6 28 2 –3 2 –25.4

5 PACCAR UNITED STATES 30.3 9.932 22 1 11 6 5 0 7 24.3

6 HYUNDAI MOTOR SOUTH KOREA 30.3 10.503 –4 33 1 –2 2 –29 25 12.7

7 NISSAN MOTOR JAPAN 29.8 51.632 20 1 12 0 1 –10 26 0.7

8 TATA MOTORS INDIA 22.9 3.274 68 9 –1 11 2 –4 7 –7.0

9 PORSCHE GERMANY 20.9 10.353 –5 17 12 –10 2 0 0 13.2

10 GENTEX UNITED STATES 17.3 3.374 28 16 1 0 0 –1 1 –21.1


# Company Country (%) ($billions) (%) (%) (%) (%) (%) (%) (%) (%)

THE AUTOMOTIVE TOP TEN, 1999–2003


NOTE: n = 42 companies with market valuation greater than $3 billion.1Contribution of each factor is shown in percentage points of five-year average annual TSR.2Average annual total shareholder return, 1999–2003.3As of December 31, 2003.4Expectation premium as percentage of total 2003 market value.5Change in EBITDA multiple.6As of October 13, 2004.

369

196171

146

241

9999 11286

117

–60

–30

30

60

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

9.0

5.55.1

6.6 6.4

5.3

7.6

9.1

6.15.6

5.8

6.2

1.11.21.21.2

1.31.2

0.90.91.01.0

1.1 1.1

10.0

5.1

6.27.3 6.9

9.0

5.85.16.67.1

6.2100

100

10.5

100

1000

0.4

0.6

0.8

1.0

1.2

1.4

0

50

100

150200

250

300

350

400

0

2

4

6

8

10

12

0

2

4

6

8

10

–4

–2

0

2

4

020406080

100120140160 152

127

123

107

143

122

145140110

132


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total sample, n = 42Automotive top ten

Total industry sample Automotive top ten

0

50

100

150

200

0

50

100

150

200

250250


223

80%

20%

100

75%

25%

100

24%

132

93%

76%

135

93%

226

84%

16%

Valueindex1

Valueindex1

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

7%7%

13%/year

19%/year–19%/year

10%/year

n = 42 n = 10

62 BCG REPORT


SOURCES: Thomson Financial Worldscope; BCG analysis.



VALUE CREATION AT TOP TEN VERSUS INDUSTRY SAMPLE, 1999–2003 ( I )



’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Sales

growthMarginchange

Multiplechange

Dividendyield

7.1

7.67.4

7.9

6.8

7.2

8.7

7.3

8.0

6.9

7.37.1

1.3

3.3

1.8

1.5

1.91.51.5

1.1

3.3

1.41.7

1.3

100

1009.4 9.7

11.111.7

11.011.4

10.910.7

9.69.9

13.614.5

’98 ’99 ’00 ’01 ’02 ’030

50100150200250300350400

100

369

196171

146

241

9999 11286

117100

80

90

100

110

120

130

140

150

109117 118 121 124

145

125117116

133

8

10

12

14

16

–2

0

2

4

6

8

10

12

9

22

0

10

23

5

5

6

7

8

9

0

1

2

3

4

ƒ

Total sample, n = 42Automotive top ten



Sales growth


EBITDA margin1



63The Next Frontier

VALUE CREATION AT TOP TEN VERSUS INDUSTRY SAMPLE, 1999–2003 ( I I )





COMPARATIVE MULTIPLE ANALYSIS , AUTOMOTIVE AND SUPPLY, 1999–2003

Actual multiple

Predicted multiple

Priority Drivers1. Gross margin 54%2. Market cap > $400 million 28%3. Operating expenses as % of revenue 11%4. Debt-to-assets ratio 7%

Each dot plots a company’s actual multiple for a given year against the multiple predicted by the regression analysis. (R2 = correlation coefficient.)

R2=.78



First quartile

Second quartile

Third quartile

Fourth quartile

n = 36

Number of companies


TSR (%)

22.8

10.5

4.4

–1.7

0

9

18

27

36

–20 –10 0 10 20 30 40 50

Reliance IndustriesJSR

Formosa Chemical & Fibre

Nitto DenkoJohnson Matthey

PraxairHitachi Chemical

Sigma-AldrichNan Ya Plastics

Formosa Plastics




64 BCG REPORT

Chemicals

TSR Decomposition1



1 RELIANCE INDUSTRIES INDIA 38.6 17.537 44 35 –6 9 3 –8 6 –2.9

2 JSR JAPAN 32.4 5.718 65 1 8 16 1 0 4 –20.1

3 FORMOSA CHEM. & FIBRE TAIWAN 26.6 7.580 48 21 3 –3 3 –1 4 21.9

4 NITTO DENKO JAPAN 25.7 9.242 65 4 5 18 1 –2 1 –13.2

5 JOHNSON MATTHEY UNITED KINGDOM 22.8 3.921 33 7 1 10 4 0 1 1.0

6 PRAXAIR UNITED STATES 18.4 12.422 42 3 –1 8 2 –1 6 12.3

7 HITACHI CHEMICAL JAPAN 17.1 3.481 35 –3 2 7 1 0 11 –9.8

8 SIGMA-ALDRICH UNITED STATES 15.3 3.965 50 6 0 1 1 8 –1 1.0

9 NAN YA PLASTICS TAIWAN 15.2 9.508 43 6 –3 7 3 –3 5 13.6

10 FORMOSA PLASTICS TAIWAN 14.1 7.929 50 16 –4 2 2 –3 0 9.1

THE CHEMICAL TOP TEN, 1999–2003



65The Next Frontier

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

10.5

9.3

10.3

11.0 11.0

9.3

9.9

10.510.810.6

10.7

10.0

0.7 0.7 0.7 0.7

0.6 0.6 0.6 0.6 0.6 0.6

7.0

5.9

6.9 6.8 7.06.4

6.16.36.86.46.8

100

100

7.1

100

100

0

50

100

150

200

250

300 270

145157168 168

115126 134105

131

0

2

4

6

8

8

9

10

11

–4

–2

0

–30

–15

0

020406080

100120140160180

153131122

111

143

115114 117117

104

0.4

0.5

0.6

0.7


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total sample, n = 36Chemical top ten

Total industry sample Chemical top ten

0

50

100

150

200

0

50

100

150

200

250250


224

53%

47%

100

77%

23%

100

26%

118

74%74%

121

74%

225

55%

45%

Valueindex1

Valueindex1

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

26%26%

36%/year

9%/year

3%/year

3%/year

n = 36 n = 10








66 BCG REPORT

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Sales

growthMarginchange

Multiplechange

Dividendyield

8.19.2

8.6

10.4

9.9

10.211.3

8.8

12.9

8.2

13.8

8.9

1.8

3.2

2.2

1.3

2.8

2.12.2

1.5

3.0

1.7

2.4

0.9

100

100

15.4 15.5

16.6 16.4 16.2

14.6

14.714.613.8

15.715.2

16.0

’98 ’99 ’00 ’01 ’02 ’03

100

100

0

50

100

150

200

250

300 270

145157168 168

115126 134105

131

80

90100

110120

130140

150

160

101 114 115 112116

153

135

115

99

142

12

14

16

18

–4

–2

0

2

4

6

8

10 9

3

1

–2

8

32

3

6789

101112131415

0

1

2

3

4

Total sample, n = 36Chemical top ten

ƒ



Sales growth


EBITDA margin1








COMPARATIVE MULTIPLE ANALYSIS , CHEMICALS, 1999–2003

Actual multiple

Predicted multiple

Priority Drivers1. Gross margin 65%2. Quick ratio1 12%3. Asset growth 11%4. Net-debt-to-market-cap ratio 7%3. Operating expenses as % of revenue 5%

R2=.79


SOURCE: BCG ValueScience Center

1A company’s “quick ratio” is its ratio of current assets to current liabilities and is a measure of working capital.

67The Next Frontier


First quartile

Second quartile

Third quartile

Fourth quartile

n = 68

Number of companies


TSR (%)

–20 –15 –10 –5 0 5 10 15 20 25 30 35

17.1

6.4

2.3

–4.2

0

17

34

51

68

TiffanyKonica Minolta

SyscoImperial Tobacco

Pernod-RicardHermes Christian DiorLVMH

Fortune Brands

British American Tobacco




Consumer Goods

TSR Decomposition1



1 TIFFANY & COMPANY UNITED STATES 29.0 6.628 61 12 9 7 1 –1 0 –33.5

2 KONICA MINOLTA JAPAN 24.7 7.149 53 –1 8 4 2 0 11 5.2

3 SYSCO UNITED STATES 23.6 24.093 62 12 4 4 2 1 1 –18.0

4 FORTUNE BRANDS UNITED STATES 20.8 10.428 38 5 1 8 3 3 1 2.4

5 IMPERIAL TOBACCO UNITED KINGDOM 20.0 14.321 –3 26 –5 –3 4 –3 0 16.3

6 PERNOD-RICARD FRANCE 18.8 7.837 17 2 13 1 4 1 –2 24.9

7 HERMES INTERNATIONAL FRANCE 18.8 7.131 44 10 6 0 2 0 1 2.1

8 CHRISTIAN DIOR FRANCE 18.4 11.010 –20 11 2 –15 3 0 17 7.3

9 LVMH FRANCE 15.7 35.658 40 12 3 –2 3 0 1 –0.1

10 BRIT. AMERICAN TOBACCO UNITED KINGDOM 15.4 28.677 6 8 6 –1 8 –6 –1 9.5

THE CONSUMER GOODS TOP TEN, 1999–2003



68 BCG REPORT

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

12.3

11.2

10.2

10.8

11.8

11.1

11.1

12.5

10.810.4

10.2 11.1

1.1

0.9

1.01.1

1.21.2

1.0

0.91.01.01.0

0.9

11.6

11.5

12.612.3

11.6 11.4

11.5

10.5

11.6

9.710.2

11.6

100

100

0

30

60

’98 ’99 ’00 ’01 ’02 ’03

100

100

0

50

100

150

200

250

300244

171185175 179

103108 1129895

8

9

10

11

12

13

8

9

10

11

12

13

0

2

4

6

0

50

100

150

200 172158

145131

166

138129144139

107

0.4

0.6

0.8

1.0

1.2

1.4


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total sample, n = 68Consumer goods top ten

Total industry sample Consumer goods top ten

0

50

100

150

200

0

50

100

150

200

250250


198

75%

25%

100

80%

20%

100

50%

106

71%50%

107

72%

197

74%

26%

Valueindex1

Valueindex1

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

27%29%

20%/year

13%/year

–9%/year

9%/year

n = 68 n = 10








69The Next Frontier

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

10.3

9.49.4

10.611.2

9.7

11.6

10.39.8

9.1

13.712.4

3.4 3.5

2.83.1

3.3

2.7

3.7

2.3

2.8

2.22.02.2

100

100 15.916.2

16.016.5

18.6 18.3

17.516.917.1

16.8

18.4

20.0

’98 ’99 ’00 ’01 ’02 ’03

100

100

11

45

2

–2

–5

42

0

1

2

3

4

0

50

100

150

200

250

300244

171185175 179

103108 1129895

8090

100110120130140150160170

102111 114 118 120

158150

141

118

155

14

15

16

17

18

19

20

21

–6–4–2

02468

1012

8

9

10

11

12

13

14

Total sample, n = 68Consumer goods top ten

ƒ



Sales growth


EBITDA margin1








COMPARATIVE MULTIPLE ANALYSIS , CONSUMER GOODS, 1999–2003

Actual multiple

Predicted multiple

Priority Drivers1. Gross margin 97%2. Dividend payout 1%3. Net-debt-to-market-cap ratio 1%4. Asset growth 1%

R2=.89



70 BCG REPORT


First quartile

Second quartile

Third quartile

Fourth quartile

n = 67

Number of companies


TSR (%)

–40 –20 0 20 40 60 80 100 120

27.6

13.5

5.7

–2.3

0

18

36

54

72 Impala Platinum

EmbraerLennarFreeport-McMoRan

DR Horton

IncoPosco

Siam CementAnglo American Platinum

Gold Fields




Industrial Goods, Engineering, and Raw Materials

TSR Decomposition1



1 EMBRAER BRAZIL 108.7 5.841 59 43 0 44 3 –4 22 –26.8

2 IMPALA PLATINUM SOUTH AFRICA 56.4 5.786 35 31 11 8 8 –1 –1 –5.1

3 SIAM CEMENT THAILAND 36.7 7.693 33 8 1 1 3 0 25 1.5

4 ANGLO AM. PLATINUM SOUTH AFRICA 36.6 9.404 61 12 2 19 8 0 –4 –3.9

5 GOLD FIELDS SOUTH AFRICA 36.0 7.024 52 37 42 –34 4 –14 1 –3.8

6 LENNAR CORPORATION UNITED STATES 33.4 7.491 –18 30 2 –1 0 –4 5 –9.0

7 FREEPORT-MCMORAN UNITED STATES 32.5 7.227 23 5 0 9 1 –2 20 –0.7

8 DR HORTON UNITED STATES 29.1 6.815 5 31 7 –4 1 –8 3 0.1

9 INCO CANADA 26.1 7.384 –4 7 22 –11 0 –2 10 –4.5

10 POSCO SOUTH KOREA 24.1 12.171 –26 6 4 –3 4 3 10 13.4

THE INDUSTRIAL GOODS TOP TEN, 1999–2003



71The Next Frontier

459

285

203187

317

124134 147109126

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

18.6

8.78.8

18.2 19.0

9.6

18.616.8

10.08.9

15.9

9.4

0.8 0.80.80.80.80.9

0.70.60.60.6

0.5 0.5

11.8

6.9

7.78.7

8.1

10.9

7.37.7

11.1

7.27.4100

100

11.2

100

100

–5

–3

0

–40

–20

0

050

100150200250300350400450500

4

6

8

10

12

14

0

5

10

15

20

020406080

100120140160

138116108107

126

129121140135

110

0.0

0.2

0.4

0.6

0.8

1.0


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total sample, n = 67Industrial goods top ten

’98 ’99 ’00 ’01 ’02 ’03 ’042 ’98 ’99 ’00 ’01 ’02 ’03 ’042–50

0

50

100

150

200

250

300

–50

0

50

100

150

200

250

300


150

82%

18%100

87%

13%

160

80%

20%

257

83%

17%

100

–19%

119%

256

84%

16%

12%/year16%/year

7%/year

Total industry sample Industrial goods top tenValueindex1

Valueindex1

n = 67 n = 10








72 BCG REPORT

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

6.5

7.8

6.8

9.3

7.3

8.5

9.5

5.7

10.2

6.2

10.68.6

2.12.5

3.7

2.11.7

3.63.6

2.11.7

2.2

1.61.8

100

100

13.4 13.2

21.224.2 25.4 24.9

13.113.613.914.6

25.023.0

’98 ’99 ’00 ’01 ’02 ’03

100

100

17

5

20

4442

0

1

2

3

4

050

100150200250300350400450500 459

285

203187

317

124134 14710912680

100

120

140

160

180

200

220

102112 117 119

127

199

146136

110

171

0

5

10

15

20

25

30

–202468

1012141618

4

5

6

7

8

9

10

11

Total sample, n = 67Industrial goods top ten

ƒ



Sales growth


EBITDA margin1








COMPARATIVE MULTIPLE ANALYSIS , INDUSTRIAL GOODS, 1999–2003

Actual multiple

Predicted multiple

Priority Drivers1. Gross margin 37%2. Asset growth 19%3. Dividend payout 19%4. Net-debt-to-market-cap ratio 13%5. Operating expenses as % of revenue 12%

R2=.90



73The Next Frontier


First quartile

Second quartile

Third quartile

Fourth quartile

n = 39

Number of companies


TSR (%)

–30 –20 –10 0 10 20 30 40 50

13.3

8.2

1.6

–11.3

0

10

20

30

40 TF1Scripps

Publishing & BroadcastingGrupo Televisa

Publicis Groupe

Knight Ridder

Tribune CompanyOmnicom Group

EchostarUnivision




Media and Entertainment

TSR Decomposition1



1 ECHOSTAR UNITED STATES 41.2 8.864 52 39 0 0 0 –6 8 –2.4

2 UNIVISION UNITED STATES 17.1 10.066 43 17 5 6 0 –11 1 –22.2

3 TF1 FRANCE 15.6 7.505 58 11 –1 6 3 0 –2 –12.3

4 SCRIPPS UNITED STATES 14.7 5.887 48 5 –2 9 1 –1 2 5.9

5 PUBL & BROADCASTING AUSTRALIA 14.1 6.224 37 17 –3 1 2 –5 1 12.5

6 GRUPO TELEVISA MEXICO 12.5 9.611 53 0 7 –2 0 7 1 37.5

7 PUBLICIS GROUPE FRANCE 12.3 6.333 13 37 –2 –1 1 –16 –8 –6.8

8 KNIGHT RIDDER UNITED STATES 10.5 6.182 40 –1 1 7 2 0 2 –13.0

9 TRIBUNE COMPANY UNITED STATES 10.5 16.112 27 13 –1 2 1 –6 2 –15.9

10 OMNICOM GROUP UNITED STATES 9.6 16.593 43 15 0 –2 1 –1 –2 –15.4

THE MEDIA AND ENTERTAINMENT TOP TEN, 1999–2003



74 BCG REPORT

196169

184

226

147

106120

8972

148

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

7.5

6.9

9.9

10.5 9.9

8.3

8.5

10.3

9.68.6

10.4

6.2

1.21.4

1.11.11.11.1

0.60.60.5

0.4

0.8 0.8

9.2

5.8

11.1 11.1

4.3

9.7

3.64.1

10.5

6.88.1100

100

9.3

100

100

0

50

100

150

200

250

0

2

4

6

8

10

12

14

0

3

6

9

12

–0.8–0.6–0.4–0.2

00.20.40.60.8

–50

–25

0

25

50

0

50

100

150

200

250

300

350

231

180158

114

211

292284256250

132

0.00.2

0.40.6

0.81.0

1.21.4

1.6


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total sample, n = 39Media top ten

0

50

100

150

200

0

50

100

150

200

250250


227

60%

40%

100

59%

41%

100

45%

150

83%

55%

141

90%

208

65%

35%

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

10%17%

17%/year

18%/year

–10%/year

18%/year

Total industry sample Media and entertainment top ten

Valueindex1

Valueindex1

n = 39 n = 10








75The Next Frontier

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

12.4

13.615.1

15.419.7

11.5

17.8

16.5

12.6

12.3

24.4

13.5

1.4

1.7

0.90.8

1.4 1.0

1.9

0.8

1.6

0.90.7

1.2

100100

16.0 16.0

16.8 16.617.8

16.7

11.311.713.1

14.9

16.6

18.0

’98 ’99 ’00 ’01 ’02 ’03

100

100

19

10

–8

1 1

–2

1 1

0

50

100

150

200

250196

169184

226

147

10612089

72

148

80

130

180

230

280

330

128149

174 180 177

293

193163

114

243

10

12

14

16

18

20

–10

–5

0

5

10

15

20

25

10

1214

16

18

2022

24

26

0

1

2



Sales growth


EBITDA margin1



Total sample, n = 39Media top ten

ƒ






COMPARATIVE MULTIPLE ANALYSIS , MEDIA AND ENTERTAINMENT, 1999–2003

Actual multiple

Predicted multiple

Priority Drivers1. EBITDA margin 35%2. Market cap > $2 billion 20%3. Capital expenditure as % of revenue 17%4. Revenue growth 16%5. Net-debt-to-market-cap ratio 12%

R2=.65



76 BCG REPORT


First quartile

Second quartile

Third quartile

Fourth quartile

n = 26

Number of companies


TSR (%)

–20 –10 0 10 20 30 40

18.6

9.3

5.6

–3.3

0

7

14

21

28 Wipro3M

WesfarmersWharf Holdings

ITT Industries

SiemensMitsubishiBouygues

ItochuCitic Pacific




Multibusiness

TSR Decomposition1



1 WIPRO INDIA 36.8 8.860 83 25 22 –11 0 0 1 8.9

2 3M UNITED STATES 21.7 66.579 59 4 3 9 3 1 2 –5.6

3 WESFARMERS AUSTRALIA 19.7 7.512 43 21 1 1 5 –8 0 24.4

4 WHARF HOLDINGS HONG KONG 18.6 6.778 –14 1 2 2 5 –1 10 23.0

5 ITT INDUSTRIES UNITED STATES 14.9 6.847 41 5 3 6 2 1 –1 7.8

6 SIEMENS GERMANY 13.5 71.692 24 4 –1 5 2 0 3 –2.1

7 MITSUBISHI JAPAN 12.9 16.612 5 –3 11 –1 1 0 5 10.5

8 BOUYGUES FRANCE 11.7 11.697 4 8 11 –4 2 –4 –1 15.3

9 ITOCHU JAPAN 11.1 5.231 1 –8 22 –25 1 –2 24 37.9

10 CITIC PACIFIC HONG KONG 9.7 5.581 7 13 –20 4 7 –1 6 7.9

THE MULTIBUSINESS TOP TEN, 1999–2003



77The Next Frontier

’98 ’99 ’00 ’01 ’02 ’03

100

100

0

50

100

150

200

250210

190217

201

148

134154

11685

154

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

5.0

3.4

2.0

4.6

5.7

2.5

5.2 5.1

3.42.4

3.7

3.0

2.0 2.02.02.02.12.3

1.21.31.41.5

1.81.6

6.6

5.8

6.87.4

6.8

7.4

6.2

4.8

8.6

5.14.4

6.7

100

100

0

2

4

6

8

10

0

2

4

6

8

–10

–5

0

–30

–15

0

020406080

100120140160180

105113104101 106

125116

159

133

107

0.0

0.5

1.0

1.5

2.0

2.5


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total sample, n = 26Multibusiness top ten


131

74%

26%100

84%

16%

100

28%

126

91%

72%

133

86%

131

74%

26%

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

14%9%18%/year

3%/year

–16%/year

10%/year

0

50

100

150

200

0

50

100

150

200

Total industry sample Multibusiness top ten

Valueindex1

Valueindex1

n = 26 n = 10








78 BCG REPORT

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

13.1

15.316.8

17.319.2

11.2

17.7

16.4

12.8

13.2

21.5

17.22.5

4.3

2.42.2

2.52.1

3.1

2.2

4.2

1.82.22.3

100

100

3.6 3.9

5.96.9

8.27.7

5.65.0

4.04.6

7.8 8.1

’98 ’99 ’00 ’01 ’02 ’03

100

100

–2

0

9

6

0

–2

3 3

0

50

100

150

200

250210

190217

201

148

134154

11685

154

80

85

90

95

100

105

95 96 96

100

92

99

9495 9698

2

4

6

8

10

–4

–2

0

2

4

6

8

10

8

1012

14

16

1820

22

24

0

1

2

3

4

5

Total sample, n = 26Multibusiness top ten

ƒ



Sales growth


EBITDA margin1








COMPARATIVE MULTIPLE ANALYSIS , MULTIBUSINESS, 1999–2003

Actual multiple

Predicted multiple

Priority Drivers1. Net income margin 68%2. Dividend payout 32%

R2=.80



79The Next Frontier


First quartile

Second quartile

Third quartile

Fourth quartile

n = 53

Number of companies


TSR (%)

25.5

11.6

1.7

–6.0

–30 –20 –10 0 10 20 30 40 50 60 70

0

13

26

39

52Laboratory CorpGilead Sciences

Stryker

Biogen Idec Forest Laboratories

St. Jude MedicalBarr Pharmaceuticals

Millennium PharmaceuticalsAltana

Boston Scientific




Pharmaceuticals and Biotech

TSR Decomposition1



1 LABORATORY CORP UNITED STATES 60.8 5.287 2 13 12 8 0 –19 47 16.2

2 GILEAD SCIENCES UNITED STATES 41.5 11.802 80 48 0 0 0 –4 –2 30.0

3 BIOGEN IDEC UNITED STATES 36.2 12.023 38 40 –48 68 0 –22 –2 64.2

4 FOREST LABORATORIES UNITED STATES 36.0 22.596 37 37 21 –19 0 –3 0 –24.2

5 ST JUDE MEDICAL UNITED STATES 34.5 10.585 48 15 1 16 0 0 3 18.5

6 BARR PHARMACEUTICALS UNITED STATES 29.3 5.172 20 19 12 2 0 –5 1 –26.8

7 STRYKER UNITED STATES 25.5 16.958 29 27 2 –7 0 –1 5 5.0

8 MILLENNIUM PHARM. UNITED STATES 23.6 5.619 59 35 0 0 0 –10 –1 –33.5

9 ALTANA GERMANY 22.9 8.479 –26 13 9 0 2 0 –2 –0.5

10 BOSTON SCIENTIFIC UNITED STATES 22.4 30.112 65 1O 1 9 0 –1 3 2.6

THE PHARMACEUTICAL AND BIOTECH TOP TEN, 1999–2003



80 BCG REPORT

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

15.6

15.5

11.9

14.9 15.0

13.1

15.5 16.0

14.613.0

14.6

15.6

1.2

0.8

1.21.2

1.01.1 1.1

1.01.11.1

0.8

1.0

18.0

12.6

15.3 15.117.7 18.3

16.314.3

15.8

13.0

9.9

16.7

100

100

’98 ’99 ’00 ’01 ’02 ’03

100

100

0.0

0.5

1.0

1.5

0

50

100

150

200

250

300

350 325

228210

124

222

112125

998995

0

5

10

15

20

0

5

10

15

20

0

10

20

30

40

50

60

0

50

100

150

200

250

300241

121106104

154

143131 183156

121

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total sample, n = 53Pharmaceutical and biotech top ten


375

58%

42%

100

42%

58%

100

60%

114

89%

40%

111

94%

402

58%

42%

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

6%11%

22%/year

39%/year–28%/year

21%/year

0

100

200

300

400

0

100

200

300

400

Total industry sample Pharmaceutical and biotech top ten

Valueindex1

Valueindex1

n = 53 n = 10








81The Next Frontier

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

20.3

25.0

17.9

28.9

19.0

13.2

27.1

22.6

13.2

19.519.4

23.0

1.0

0.2

0.7

1.2

0.2

0.70.8

0.2

1.4

0.10.40.2

100

100

18.820.0

21.222.3 22.3 22.8

23.222.8

20.0

22.1

24.324.9

’98 ’99 ’00 ’01 ’02 ’03

100

100

10

18

13

62

4

–10

0

50

100

150

200

250

300

350 325

228210

124

222

112125998995

80

100120

140

160

180200

220

240

119

171187

228

158

137124

192

161148

16

18

20

22

24

26

–15

–10

–5

0

5

10

15

20

1012141618202224262830

0

1

2

Total sample, n = 53Pharmaceutical and biotech top ten

ƒ



Sales growth


EBITDA margin1








COMPARATIVE MULTIPLE ANALYSIS , PHARMACEUTICALS AND BIOTECH, 1999–2003

Actual multiple

Predicted multiple

Priority Drivers1. Gross margin 62%2. Market cap > $1 billion 14%3. R&D as % of revenue 11%4. Net-debt-to-market-cap ratio 8%5. Operating expense as % of revenue 5%

R2=.70



82 BCG REPORT


First quartile

Second quartile

Third quartile

Fourth quartile

n = 29

Number of companies


TSR (%)

34.7

13.0

7.1

2.9

0

7

14

21

28

–10 0 10 20 30 40 50 60 70 80

Votorantim Celulose

AracruzCeluloseSappi

CMPCMayr-Melnhof Karton

Holmen

Svenska CellulosaDomtar

Rayonier

Norbord




Pulp and Paper

TSR Decomposition1



1 VOTORANTIM CELULOSE BRAZIL 74.2 1.088 –16 38 14 12 4 –1 6 11.4

2 ARACRUZ CELULOSE BRAZIL 69.6 3.133 35 52 0 0 7 0 10 –6.8

3 EMPRESAS CMPC CHILE 35.0 4.000 –11 14 7 1 3 0 11 6.0

4 SAPPI SOUTH AFRICA 34.7 3.259 –14 5 –2 9 3 –1 22 2.4

5 MAYR-MELNHOF KARTON AUSTRIA 22.5 1.442 –5 8 0 3 3 2 6 21.7

6 HOLMEN SWEDEN 22.3 2.860 –26 –7 4 7 16 2 0 2.4

7 NORBORD CANADA 18.2 1.244 –19 3 7 –6 6 1 7 56.3

8 SVENSKA CELLULOSA SWEDEN 15.9 9.488 –22 7 –1 3 4 –2 5 2.2

9 DOMTAR CANADA 14.1 2.875 5 15 –7 7 1 –4 3 –2.6

10 RAYONIER UNITED STATES 13.7 2.094 31 2 1 6 4 0 1 16.7

THE PULP-AND-PAPER TOP TEN, 1999–2003



83The Next Frontier

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03’98 ’99 ’00 ’01 ’02 ’03

15.3

8.99.9

14.516.7

10.9

15.3 14.7

11.910.9

13.3

10.0

0.6

0.6

0.6

0.6

0.6

0.6

0.6

0.6

0.6

0.6

0.6

0.6

8.5

4.9

7.28.5

10.08.6

5.66.3

7.16.75.8100

100

8.1

100

100

0.4

0.5

0.6

0.7

0

50

100

150

200

250

300

350302

227

162187

246

136123153

124152

0

2

4

6

8

10

12

0

5

10

15

20

–4

–3

–2

–1

0

–25

–20

–15

–10

–5

0

020

40

60

80

100

120

140160

136122

105101

132

132127143139

105


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total sample, n = 29Pulp-and-paper top ten


100

119%

–19%

153 157

106% 105%

–6% –5%

100

144%

–44%

180

108%

–8%

182

109%

–9%

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

6%/year6%/year

–50

0 0

50

100

150

200

–50

50

100

150

200

Total industry sample Pulp-and-paper top ten

Valueindex1

Valueindex1

n = 29 n = 10








84 BCG REPORT

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

6.0

9.6

6.8

7.9

7.4 6.8

6.9

4.8

7.5

8.28.68.1

2.8 4.1

5.7

3.35.1 3.2

7.9

4.3

4.6

2.83.12.6

100

100 14.315.5

16.9

18.9

21.7

19.7

13.114.0

15.316.8

19.5 19.0

’98 ’99 ’00 ’01 ’02 ’03

100

100

76

2

–2

5

3

54

0

50

100

150

200

250

300

350 302

227

162187

246

136123153

124152

80

90

100

110

120

130

140

150

112

131 132138

125

115108

134

137135

10

12

14

16

18

20

22

24

–3–2–1012345678

0

2

4

6

8

10

12

0123456789

Total sample, n = 29Pulp-and-paper top ten

ƒ



Sales growth


EBITDA margin1








COMPARATIVE MULTIPLE ANALYSIS , 1999–2003

Actual multiple

Predicted multiple

Priority Drivers1. EBITDA margin 57%2. Dividend payout 28%3. Net-debt-to-market-cap ratio 15%

R2=.73



85The Next Frontier


First quartile

Second quartile

Third quartile

Fourth quartile

n = 55

Number of companies


TSR (%)

19.4

7.7

–1.8

–10.1

0

14

28

42

56

–30 –20 –10 0 10 20 30

AutozoneBest Buy

Bed Bath & Beyond Woolworths

StarbucksLowe’s Companies

IAC/InterActiveCorp

eBayWal-Mart de Mexico

Next




Retail

TSR Decomposition1



1 EBAY UNITED STATES 26.3 41.737 78 69 10 –48 0 –7 0 45.1

2 WAL-MART DE MEXICO MEXICO 22.7 11.142 54 11 7 5 1 1 –2 20.8

3 NEXT UNITED KINGDOM 21.8 5.515 17 14 0 1 4 6 –3 53.0

4 AUTOZONE UNITED STATES 20.9 7.436 12 11 5 –5 0 12 –2 –9.6

5 BEST BUY UNITED STATES 20.7 16.961 34 20 15 –11 0 –4 1 6.3

6 BED BATH & BEYOND UNITED STATES 20.5 12.935 48 26 3 –9 0 –1 1 –9.6

7 WOOLWORTHS AUSTRALIA 20.0 9.037 47 10 3 1 4 2 0 19.9

8 STARBUCKS UNITED STATES 18.8 13.061 71 25 1 –5 0 –2 0 44.2

9 LOWE’S UNITED STATES 17.0 43.556 48 20 7 –8 0 –2 0 –0.4

10 IAC/INTERACTIVECORP UNITED STATES 15.4 22.438 38 18 –1 1 0 –15 12 –38.6

THE RETAIL TOP TEN, 1999–2003



86 BCG REPORT

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

6.2

5.05.0

5.9 6.0

4.9

5.2

6.6

5.15.0

5.7

5.0

2.2

2.02.1

2.22.32.3 2.2

2.2

2.5

2.12.2 2.2

13.5

10.9

12.3 12.713.4 12.9

10.810.611.011.311.2100

100

13.2

100

100

0

50

100

150

200

250

300253

188

112

128

164

112105 10786

131

5

10

15

0

2

4

6

8

’98 ’99 ’00 ’01 ’02 ’03

0

1

2

3

0

5

10

15

20

25

0

50

100

150

200

250 233

136135

119

182151140

163157

118

1.0

1.5

2.0

2.5

3.0


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total sample, n = 55Retail top ten


60%

100

40%

31%

114118

69%

27%

73%

100

281

315

59%

41%

51%

49%

49%

51%

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

19%/year

27%/year

–10%/year

14%/year

0

50

100

150

200

250

300

0

50

100

150

200

250

300

Total industry sample Retail top ten

Valueindex1

Valueindex1

n = 55 n = 10








87The Next Frontier

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

16.4

16.9

13.8

20.7

17.9

10.2

13.1

12.6

10.9

13.7

18.019.4

1.4

1.2

1.51.4

0.8

1.11.0

1.0

2.1

0.7

1.1

0.7

100

100

7.7

7.87.6

9.19.7

8.4

8.07.77.68.0

9.5

10.7

15

96

1 1 1

–8

–3

80

100120

140

160

180200

220

240

117132

143151 158

215

157140

119

184

6

7

8

9

10

11

–10

–5

0

5

10

15

20

8

10

12

14

16

18

20

22

0

1

2

3

’98 ’99 ’00 ’01 ’02 ’030

50

100

150

200

250

300

100

100

253

188

112

128

164

112105 10786

131

Total sample, n = 55Retail top ten

ƒ



Sales growth


EBITDA margin1








COMPARATIVE MULTIPLE ANALYSIS , RETAIL , 1999–2003

Actual multiple

Predicted multiple

Priority Drivers1. Gross margin 82%2. Market cap > $2 billion 8%3. Revenue growth 6%4. Net-debt-to-market-cap ratio 4%


R2=.77


88 BCG REPORT


First quartile

Second quartile

Third quartile

Fourth quartile

n = 81

Number of companies


TSR (%)

–60 –40 –20 0 20 40 60

18.8

5.8

–4.1

–15.1

0

20

40

60

80SK Telecom

Electronic ArtsAnalog Devices

Veritas Software KLA-Tencor

QualcommSamsung Electronics

Symantec

NextelXilinx




Technology

TSR Decomposition1



1 QUALCOMM UNITED STATES 53.0 43.148 50 4 32 18 0 –6 5 53.5

2 SYMANTEC UNITED STATES 44.7 10.628 45 23 18 10 0 –5 –1 61.5

3 SAMSUNG ELECTRONICS SOUTH KOREA 44.2 61.926 40 21 –3 10 3 –3 15 –0.1

4 SK TELECOM SOUTH KOREA 28.2 13.742 18 24 3 1 1 –2 1 –8.8

5 ELECTRONIC ARTS UNITED STATES 27.7 14.202 52 22 14 –5 0 –4 0 –6.0

6 ANALOG DEVICES UNITED STATES 23.8 16.973 69 11 3 9 0 –3 3 –15.6

7 VERITAS SOFTWARE UNITED STATES 22.7 15.829 61 47 3 –13 0 –14 1 –44.3

8 KLA-TENCOR UNITED STATES 22.0 11.398 76 2 –5 26 0 –2 0 –29.2

9 NEXTEL COMMUNICATIONS UNITED STATES 18.9 29.852 42 27 0 0 0 –17 8 –12.1

10 XILINX UNITED STATES 18.9 13.225 76 13 –6 14 0 –3 1 –27.9

THE TECHNOLOGY TOP TEN, 1999–2003



89The Next Frontier

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

15.1

13.1

9.4

13.615.6

12.5

12.7 13.7

14.112.4

12.5

13.0

0.9

0.60.5

0.8

1.0

0.8

1.0

0.6

0.8

0.60.7 0.7

13.6

7.8

8.8

11.913.0

10.5

7.36.78.18.8

7.9

12.8

100

100

’98 ’99 ’00 ’01 ’02 ’030

50

100

150

200

250

’98 ’99 ’00 ’01 ’02 ’03

100

1000

100

200

300

400

500

600

700

390305

362

575

240

100130 8767

203

0

5

10

15

0

5

10

15

20

–5

–3

0

3

5

–100

–50

0

50

100 219191

174

112

209

170154 157158120

0.0

0.2

0.4

0.6

0.8

1.0

1.2


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total sample, n = 81Technology top ten


52%

100

48%

22%105 102

78%

15%

85%

100

401 418

37%

63%

48%

52%

44%

56%

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

39%/year

27%/year–15%/year

12%/year

0

100

200

300

400

0

100

200

300

400

Total industry sample Technology top ten

Valueindex1

Valueindex1

n = 81 n = 10








90 BCG REPORT

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

9.8

10.7

11.7

12.620.1

7.4

12.9

12.58.7

8.2

30.3

11.5

1.1

0.5

0.60.4

0.5

0.7

1.3

0.5

1.2

0.30.00.3

100

100 18.7

23.4

22.323.5

29.7

23.6

23.6

21.721.2

24.1

26.9

24.4

’98 ’99 ’00 ’01 ’02 ’03

100

100

22

6 61 2

–4

0 1

0

100

200

300

400

500

600

700

390305

362

575

240

100130 8767

203

80100120140160180200220240260280

109125 127 125 127

192174

127

224

255

16

1820

2224

2628

30

32

–10

–5

0

5

10

15

20

25

0

5

10

15

20

25

30

35

0

1

2

Total sample, n = 81Technology top ten

ƒ



Sales growth


EBITDA margin1








COMPARATIVE MULTIPLE ANALYSIS , TECHNOLOGY, 1999–2003

Actual multiple

Predicted multiple

Priority Drivers1. Gross margin 67%2. Asset growth 13%3. Net-debt-to-market-cap ratio 11%4. Operating expense as % of revenue 9%

R2=.72



91The Next Frontier


First quartile

Second quartile

Third quartile

Fourth quartile

n = 51

Number of companies


TSR (%)

19.9

9.3

2.4

–4.1

0

13

26

39

52

–20 –10 0 10 20 30 40

Cathay Pacific

Canadian National Railway

Harrah’s Entertainment Mitsui Osk Lines

CH RobinsonMGM Mirage

RyanairExpeditors International

Genting

Pixar




Travel, Transport, and Tourism

1 RYANAIR HOLDINGS IRELAND 34.0 6.270 44 30 3 5 0 –3 0 –43.6

2 EXPEDITORS INTL UNITED STATES 29.6 3.954 44 21 –1 10 0 –1 1 42.9

3 HARRAH’S ENTERTAINMT UNITED STATES 26.3 5.498 16 17 1 2 0 –2 6 11.9

4 MITSUI OSK LINES JAPAN 26.0 5.883 24 2 –3 4 3 –2 22 33.0

5 CH ROBINSON UNITED STATES 24.9 3.201 24 13 8 5 1 –1 –1 24.4

6 MGM MIRAGE UNITED STATES 22.7 5.451 3 37 4 –3 0 –7 –8 37.3

7 CATHAY PACIFIC AIRWAYS HONG KONG 17.2 6.352 3 2 9 –2 3 0 5 –7.0

8 CANADIAN NATL RAILWAY CANADA 17.0 12.021 –15 9 4 –1 2 0 3 15.5

9 GENTING MALAYSIA 16.8 3.077 –36 8 2 6 2 0 –1 3.8

10 PIXAR UNITED STATES 14.7 3.830 –9 60 10 –51 0 –5 1 16.7

TSR Decomposition1



THE TRAVEL TOP TEN, 1999–2003



92 BCG REPORT

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

15.1

10.911.8

13.815.2

11.9

15.3 14.7

12.212.3

11.9

11.9

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.5

7.8

5.4

5.8

7.4 7.9 7.6

5.85.96.16.05.7

7.4

100

100

’98 ’99 ’00 ’01 ’02 ’03

0

5

10

15

20

–40

–30

–20

–10

0

’98 ’99 ’00 ’01 ’02 ’03

100

261

198166

141

204

104104 11491102100

0

50

100

150

200

250

300

0

5

10

–2.0

–1.5

–1.0

–0.5

0.0

020406080

100120140160180

154142

130

105

146

118112127122

104

0.3

0.4

0.5

0.6


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total sample, n = 51Travel top ten


99%105%

–5% –1%

101%

1%100

119 126

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

5%/year

–50

0

50

100

150

200

250

–50

0

50

100

150

200

250

110%

92%

8%9%

91%

–10%

100

205220

11%/year

Total industry sample Travel top ten

Valueindex1

Valueindex1

n = 51 n = 10








93The Next Frontier

100

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

’98 ’99 ’00 ’01 ’02 ’03

100

261

198166

141

204

104104 11491102100

0

50

100

150

200

250

300

8090

100110120130140150160170

100

104115

121 123130

159

145138

116

155

14

16

18

20

22

17.6

21.621.621.2

20.0

21.4

17.117.316.516.4

17.517.2

10

54

–1 –1

1 12

–2

0

2

4

6

8

10

12

9.5

10.1

9.6

9.19.3

9.0

9.79.9

9.79.2

10.4

10.0

8

9

10

11

0

1

2

3

1.1

1.7

1.20.90.9 0.8

1.71.9

2.5

1.41.51.6

ƒ



Sales growth


EBITDA margin1



Total sample, n = 51Travel top ten






COMPARATIVE MULTIPLE ANALYSIS , TRAVEL, 1999–2003

Actual multiple

Predicted multiple

Priority Drivers1. EBIT margin 44%2. Market cap > $2 billion 26%3. Asset growth 18%4. Debt-to-assets ratio 12%

R2=.70



94 BCG REPORT


First quartile

Second quartile

Third quartile

Fourth quartile

n = 48

Number of companies


TSR (%)

–20 –15 –10 –5 0 5 10 15 20

12.6

6.2

0.0

–4.7

0

12

24

36

48Hong Kong & China Gas

Fortum Centrica

PPL

Southern

Dominion Resources

EntergyHong Kong Electric

KeyspanCLP Holdings




Utilities

TSR Decomposition1



1 SOUTHERN COMPANY UNITED STATES 17.2 22.149 –11 0 –1 7 6 –1 7 4.6

2 ENTERGY CORP UNITED STATES 17.0 12.899 –44 –4 4 7 4 2 4 12.7

3 HONG KONG & CHINA GAS HONG KONG 15.3 8.614 47 6 –2 7 3 2 –2 28.9

4 FORTUM FINLAND 14.2 8.725 –40 6 7 –1 5 –2 –2 51.8

5 CENTRICA UNITED KINGDOM 13.7 16.070 –15 18 5 –13 5 1 –1 18.9

6 PPL CORPORATION UNITED STATES 13.5 7.758 –24 8 3 3 4 –2 –2 13.4

7 DOMINION RESOURCES UNITED STATES 11.6 20.707 –7 14 1 2 5 –10 0 6.4

8 HONGKONG ELECTRIC HONG KONG 10.8 8.440 –7 3 2 0 5 –1 1 19.2

9 KEYSPAN UNITED STATES 9.4 5.853 –11 29 9 –23 6 –2 –9 10.1

10 CLP HOLDINGS HONG KONG 8.9 11.477 23 4 –1 2 6 4 –6 25.8

THE UTILIT IES TOP TEN, 1999–2003



95The Next Frontier

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

18.5

16.116.6

18.5

17.7

16.6

16.816.2

16.616.8

16.9 18.2

0.4

0.30.3

0.40.40.4 0.4

0.3

0.4

0.30.3 0.3

7.1

5.0

6.8 7.2 7.0 7.0

5.35.45.45.65.6

6.8

100

100

’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03

100

100

0

5

10

–8

–6

–4

–2

0

020406080

100120140160180200 187

145147

101

154

103111 1018488

14

15

16

17

18

19

–100

–80

–60

–40

–20

0

0

20

40

60

80

100

120

140160 149

127

122

99

141132

122140139108

0.0

0.1

0.2

0.3

0.4

0.5


Cash value-added1

Profitability


Cash flow margin




Cash flow/sales (%)

$billions $billions

Total sample, n = 48Utilities top ten


106% 126%

–26% –20%

120%

–6%

100

119127

’98 ’99 ’00 ’01 ’02 ’03 ’042’98 ’99 ’00 ’01 ’02 ’03 ’042

7%/year

–50

–25

0

25

50

75

100

125

150

175

102%

113%

–13% –4%

104%

–2%

100

151165

11%/year

–50

–25

0

25

50

75

100

125

150

175

Total industry sample Utilities top ten

Valueindex1

Valueindex1

n = 48 n = 10








96 BCG REPORT

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03

’98 ’99 ’00 ’01 ’02 ’03 ’98 ’99 ’00 ’01 ’02 ’03Salesgrowth

Marginchange

Multiplechange

Dividendyield

8.0

8.7

7.9

8.5

7.4 7.5

8.8

8.7

7.7

8.28.28.5

4.04.6

4.1

6.1

3.5

4.85.4

3.4

5.2

3.5

5.4

3.9

100

100

23.122.7

23.4

24.323.5 23.6

22.3

24.1

22.2

23.5

25.2

23.3

’98 ’99 ’00 ’01 ’02 ’03

100

100

8

4

–1

01

–2

43

020406080

100120140160180200 187

145147

101

154

103111101

8488

80

90100

110

120

130140

150

160

126118

128

154

132

119

95

136

106117

20

22

24

26

–4

–2

0

2

4

6

8

10

5

6

7

8

9

0

1

2

3

4

5

6

7

ƒ



Sales growth


EBITDA margin1



Total sample, n = 48Utilities top ten






COMPARATIVE MULTIPLE ANALYSIS , UTILIT IES, 1999–2003

Actual multiple

Predicted multiple

Priority Drivers1. EBIT margin 47%2. Revenue growth 37%3. Net-debt-to-revenue ratio 16%

R2=.92



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