EVA = Economic Value Addition
As defined on Investopedia, EVA is "a measure of a company's financial performance based on the residual wealth calculated by deducting cost of capital from its operating profit (adjusted for taxes on a cash basis).
The formula for calculating EVA is as follows:
= Net Operating Profit After Taxes (NOPAT) - (Capital * Cost of Capital)"
What this metric aims to estimate is the value a company creates in excess of the required rate of return expected by its shareholders.
With the help of our database tool, I pulled out the return on equity and D/E ratios for the entire universe (barring financials and banking businesses) for the decade ending 2010. The tool threw up a list of 1,829 companies. Thereafter, I only included those companies which had a minimum RoE of 15% (long term returns of the Sensex) in each of the financial year of this period. Further, I excluded companies which had D/E ratio of more than 1x in any one of the years of this period. The latter was done to avoid the possibility of RoEs being influenced by high debt on books.
A total of 42 companies met these criteria. Then, I calculated the stock returns of these 42 companies in the past five years - i.e. from June 2010 to June 2015. I would like to point out here that this exercise does remove the factor of hindsight bias as the financial data is gauged for the period prior to calculating these returns.
The results here did pretty much surprise me! Out of these 42 companies, 40 of them beat the Sensex's returns of 9.4% per annum during this period. This is a success ratio of as high as 95%. The average returns of this group of stocks came in at a whopping 42% per annum!
