Using EVA

Economic Value Added (EVA) is a frequently used ratio by investors from developed market economies. The basic idea of this formula is based on the foundation that the main goal of a company is to maximize profit. However it does not mean book profit (the difference between revenues and costs) but economical profit.

The difference between economical and book profit is that economical profit is the difference between revenues and economical costs, which are book costs and opportunity costs. Opportunity costs are presented by the amount of money lost by not putting available sources (like capital, labor, etc.) to the best alternative use. This relation is possible to describe in following way:
Book profit = Revenues – Costs
Economical profit = Total revenues from capital – Costs of capital

A basic construction of EVA measure is clear from the following formula:
EVAt = NOPATt – Ct x WACCt
where NOPATt is Net Operating Profit After Tax,
Ct is long term capital,
WACC is Weighted Average Cost of Capital

If EVA > 0, then we can say a company is successful. This is the only case when wealth of shareholders increases because they gain more than what they put in originally. In case EVA = 0, a company produced just as much as it was invested and EVA less than 0 leads to destroying of shareholders' wealth.

Companies which can gain the highest level of profit (NOPAT) while using minimum "cheap” capital will experience positive results. It is possible when investments are consistently driven by criteria of net present value. Therefore EVA represents an interesting measure of judging the performance of companies.

What is Competitive Advantage?

The true definition i got from the internet for competitive advantage is as follows:
An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers than its competition. Competitive advantages give a company an edge over its rivals and an ability to generate greater value for the firm and its shareholders. The more sustainable the competitive advantage, the more difficult it is for competitors to neutralize the advantage.

There are two main types of competitive advantages: comparative advantage and differential advantage. Comparative advantage, or cost advantage, is a firm's ability to produce a good or service at a lower cost than its competitors, which gives the firm the ability sell its goods or services at a lower price than its competition or to generate a larger margin on sales. A differential advantage is created when a firm's products or services differ from its competitors and are seen as better than a competitor's products by customers.

What are the types of advantages that help protect you from the competition? How do you get to the point where you have a wide economic moat as Buffett calls it? Well, one thing that isnt a source of a moat is technology because that can be duplicated and always will be. Technology is one type of advantage that is short-lived. There are others, such as a good management team or a catchy advertising campaign or a hot fashion trend. These things produce temporary advantages but they change over time, or can be duplicated by competitors.

An economic moat is a structural thing. If your competitors know your secret and yet still cant copy it, thats a structural advantage. Thats a moat. Frankly, there are really only four sources of economic moats that are hard to duplicate, and thus, long-lasting. One source would be economies of scale and scope. Wal-Mart is an example of this, as is Cintas in the uniform rental business or Procter & Gamble or Home Depot and Lowes. Another source is the network affect, like eBay or Mastercard or Visa or American Express. A third would be intellectual property rights, such as patents, trademarks, regulatory approvals, or customer goodwill. Disney, Nike, or Genentech would be good examples here. A fourth and final type of moat would be high customer switching costs. Paychex and Microsoft are great examples of companies that benefit from high customer switching costs. These are the only four types of competitive advantages that are durable, because they are very difficult for competitors to duplicate.

Normally in the IPO prospectus of companies, we see the following mentioned as competitive strengths/advantages:
1) We are a leading manufacturer of XXXXXXXX.
From 2002 to 2004, we have been ranked first in terms of sales.

2) We have an established brand name.
We have built up an established brand name within the industry.

3) We are amongst the most technologically advanced manufacturers.
Our strength also lies in the technology we employ in our operations.

4) We are a manufacturer of quality products.
Several of our products have won awards for excellence and quality.

5) Our commitment and ongoing efforts to R&D.
Our management places a strong emphasis on R&D and our R&D initiatives are focused on
developing and introducing new products to cater to our customers’ needs.

6) We have an experienced and capable management team.
Our Executive Directors have approximately a total of 40 years’ experience.

Can you see the difference?