Strategies for Enhancing Total Shareholder Return (TSR)
Executives often face the challenge of enhancing their companies’ Total Shareholder Return (TSR). While the instinct is frequently to pursue growth, recent findings suggest that shareholders also value efficient capital management. Research conducted by EY has revealed that different companies may benefit from varied strategies based on their return on invested capital (ROIC).
Understanding the Paths to TSR
In a comprehensive analysis of value creation among S&P 500 companies, EY utilized a proprietary forecasted cash flow model to examine the dynamics of growth, capital investment, and TSR. The research found notable distinctions in TSR performance related to a company’s ROIC.
The study categorized S&P 500 companies as either high or low ROIC, based on their average historical ROIC from 2021 to 2024. This review encompassed 360 companies, excluding financial services, companies with fluctuating S&P 500 status during the study period, and industries still reeling from COVID-19 disruptions, such as airlines and cruise operators.
Insights from Fables: The Tortoise and the Hare
The findings resonate with lessons from classic fables. Companies were likened to characters from these tales, categorized by their ROIC and TSR strategies:
Tortoises and Hares: The Low ROIC Segment
- Tortoises: These firms achieved success through diligent efficiency improvements and disciplined growth. They focused on extracting maximum value from investments.
- Hares: Symbolizing overconfidence, these companies pursued aggressive growth without addressing operational inefficiencies, often leading to stagnation.
The tortoise approach led to sustained progress, as these companies concentrated on strategic refinements that ultimately outpaced the hares.
Ants and Grasshoppers: The High ROIC Segment
- Ants: Companies represented by the ant are systematic planners, enhancing profit margins through selective and high-return investments, thereby driving consistent growth in TSR.
- Grasshoppers: In contrast, these companies squandered their high ROIC by overinvesting in low-return projects, resulting in diminished shareholder value.
Performance Breakdown of Tortoises and Hares
Tortoise companies recognized that a low ROIC needed urgent refinement. By limiting capital expenditures, they improved ROIC by 44%, which contributed a 59% positive impact on their TSR.
Conversely, hare companies increased their investment in underperforming sectors, resulting in a negative total return. Their net TSR growth was just 30%, significantly below the tortoises, as their lower ROIC failed to offset new investments, ultimately leading to a -9% total TSR impact.
High ROIC Strategies: The Ant Effect
For firms with high ROIC, disciplined investment for growth is crucial. These companies, identified as “ants,” effectively balance investment and capital efficiency. Too much expenditure without efficiency can lead to detrimental effects on shareholder returns.
Ant companies successfully maintained or enhanced margins through strategic investments, achieving a remarkable 73% TSR growth. In stark contrast, grasshopper companies that failed to sustain their traditionally high ROIC faced a mere 10% TSR increase, illustrating the cost of ineffective investment strategies.
Guiding Principles for TSR Improvement
To carve pathways to a positive TSR, companies should adopt two foundational steps:
- Assess ROIC: Companies must evaluate their capital effectiveness against the cost of capital. This assessment will clarify whether they are positioned to seek growth.
- Define Growth Paths: For those with low ROIC, the focus should be on enhancing capital efficiency and improving profit margins. Meanwhile, those with a healthy high ROIC must make informed investments that leverage their competitive edge without compromising returns.
Conclusion
In conclusion, companies that wish to enhance their TSR must align their capital investment strategies with their operational efficiencies. By learning from both the tortoise and ants, they can navigate their paths to sustainable growth and improve overall shareholder returns.
For additional insights and comprehensive findings, readers can refer to the full EY research report titled “Earning the Right to Grow.” This report provides detailed strategies for redefining enterprise growth models through informed investment practices.
Authors: Mitch Berlin, Partner and EY Americas Vice Chair, Strategy and Transactions, and Whitt Butler, Partner and EY Americas Vice Chair, Consulting, at Ernst & Young LLP.
The viewpoints expressed in this article are those of the authors and do not necessarily reflect the opinions of Ernst & Young LLP or its global members.
