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Total Shareholder Return: Planning a Future Perfect

Total shareholder return can not only be a measure of past performance, but it can be harnessed as the prime touchstone for planning future performance.

Fortnightly Magazine - January 2006

value currently registered by the market. If they’re close, then your plans and the market’s perceptions likely are in alignment. If the market value is significantly lower, it may be that the market doesn’t know of your plans, or doesn’t believe your projections, or possibly is assigning a higher risk to your activities than you assign. If the market value is significantly higher, then the share price may be due for a downward correction unless your plans can be improved to fill the gap.

For future years in your planning horizon, increase the calculated share value by your enterprise cost of capital, compounding annually. The price paid today embeds an expectation that the return on investment will equal the cost of equity capital. 2 This is an important assumption in application of TSR as a management tool, because it means today’s calculated value will increase in step with the equity cost of capital. Over the relevant planning period, projected growth in calculated share value (assuming for the moment no dilution through dividend payouts) will be equal to the cost of capital.

Compare the calculated share price at the end of the planning period to the current actual share price ( i.e., what people are paying for your stock today without perhaps fully appreciating your plans). The difference is the growth in TSR that your current plan provides. Note that the putative share value you have calculated at the end of the period is not necessarily a prediction of share price, since some of that value will likely have been paid out in dividends. Regardless of how much or how little value growth is captured in dividends, however, the TSR calculation remains the same.

Discretionary Goal

By putting together some fairly basic calculations in this way management can see that a particular level of TSR is implied in its plans. That level can be raised or lowered by changing those plans. Accordingly, TSR can serve as a discretionary goal that frames corporate planning.

Since industry mean TSR over time will approximate the industry cost-of-equity capital, a company that wants to be among the industry leaders in value growth probably will wish to set a TSR goal in excess of the cost of capital. If its value profile does not provide that kind of growth, the company should consider adjusting its portfolio or burrowing into the constituent entities of that portfolio to see how their individual economic contributions can be improved.

So let’s put in perspective what we have. It would be foolish to contend that the result of these calculations is a firm prediction of share price years from now. Basic value drivers change in ways that management cannot control and probably cannot forecast. Interest rates and inflation rise or fall, the general economy prospers or languishes, the market goes through bear and bull phases, and so on.

These systemic phenomena doubtless will have an effect on the dollar value of a share of stock five years from now that cannot be calculated today. As with any planning tool, what the calculation