This morning, I went to see an IRO at a midcap in downtown Stockholm. Arriving at their offices, I found out that the person I was supposed to meet was not there and that she did not have our meeting in her calendar… She was on her way to the office, but did not really have the time to meet with me. These things happen, but I have to admit I was more than a little annoyed.

I had barely arrived when I was on my way out again, but I did have the time to have a look around the reception area. This is taken from an article which was stapled to a bulletin board:

I really don’t know why the photo turned out pink… Anyway, this assertion caught my eye:

“For a shareholder, earnings per share (EPS) is a more relevant concept, because this measure takes into account the effect of sales and profits that the company has acquired using its own shares as payment.”

Fine, but I don’t think this qualifies it as being relevant to shareholders, at least not in thinking about value creation. First of all, EPS is a traditional accounting measure. As such, it tells us very little about the economic value the firm has created (and even less about the future). Metrics that determine value creation are much more useful, i.e. spread (the difference between the return on invested capital and the cost of that capital) and growth. A company displaying good-looking EPS growth can actually be a value destroyer. For example, EPS growth can be the result of value-destroying investments or acquisitions.

Second, since the rules for treatment of goodwill were changed a few years ago (both in IFRS and US GAAP), EPS is even less relevant in gauging the value of an acquisition. As McKinsey pointed out in an article a few years ago, most acquisitions will now result in EPS accretion (because goodwill is not amortised). In companies where EPS is used as a performance measure, management could be incentivised to undertake deals that destroy shareholder value. McKinsey suggests looking at a deal’s impact on economic profit, calculated with a charge for goodwill at the full cost of capital.

I guess the excursion this morning was not entirely wasted, as it got me thinking about this. Also, walking in the sunshine through central Stockholm was quite nice. I passed this cool ice sculpture, promoting Kurt Weill’s The Silver Lake at Folkoperan.