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Wealth Creation Matrix™ and Wealth Creation Factor™

Finance is in a funny place now. Corporate finance operates under the guidance of the NPV Rule.

The NPV Rule provides the following guidance to corporate executives: To the extent a corporation sources investment opportunities with returns in excess of the company’s cost of capital, the assumption is firms should pursue those opportunities as they will increase the overall value of the firm.

Conversely much of the investment management profession, which is responsible for investing in public corporations, has been guided by influential research that essentially concludes higher corporate investment is associated with lower expected stock returns.

In a recent Applied Finance working paper – The Wealth Creation Effect in Stock Returns,  Francesco Franzoni, Dan Obrycki, and Rafael Resendes propose a path to reconcile these seemingly contradictory positions by exploring a long-time investment concept of ours – Wealth Creation.

Our Wealth Creation Matrix™ applies rigorous economic theory to understand the wealth creation consequences of corporate strategy to frame investment decisions, and consists of four quadrants segmenting firms by their level of Economic Margins (ROI – cost of capital) and asset growth:

Wealth Creation Matrix™

  • Wealth Destroyers – Firms that invest in negative Economic Margins® projects
  • Wealth Compounders – Firms that invest in positive Economic Margin® projects
  • Returners –Firms with positive Economic Margins® that return capital to owners
  • Turnarounds –  Firms with negative Economic Margins® shrinking their business

Corporate actions drive corporate value.

The Wealth Creation Factor™

The Wealth Creation Factor™  systematically applies the NPV Rule to corporate actions.

By incorporating the Wealth Creation Factor™ into our decision making process, we mitigate exposure to  companies that exhibit wealth-destroying traits.

The Wealth Creation Factor™
Destroyer Returns

The Wealth Creation Factor™
Factor Consistency

The Wealth Creation Factor™
Upside/Downside Capture and Drawdown

Contact us to learn how we incorporate our Wealth Creation Matrix™ and Wealth Creation Factor™ in  safeguarding our clients capital from potential pitfalls.

Author

  • Applied Finance, a thought leader in valuation and portfolio construction, is a true “value” investment management company.  Unlike the majority of firms today that focus on low multiples to define “value”, we define value as identifying companies trading below their intrinsic value.  Our Valuation Driven™ approach forms the foundation of our investment decisions...more

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