User Guide

EVA® METHODOLOGY EVA® SCORECARD

EVA IS A REGISTERED TRADEMARK OF STERN & STEWART & CO. NY, NY.

© 2001 STOCKPOINTER, INC.

Revised March 2021

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Introduction to Inovestor

Inovestor for Advisors offers investment research, idea generation, model portfolios and portfolio analytics, all in one platform. Our Canadian model portfolio has outperformed the S&P/TSX benchmark since its inception in 2008 with a lower standard deviation.

The economic value added (EVA) is a measure of corporate financial performance that hundreds of companies around the world have implemented as part of their executive incentive program. Many corporations now use an EVA approach to promote, measure and reward the creation of shareholder wealth. Up until recently, the focus of economic evaluation had been directed toward the internal financial management of companies. Inovestor now brings this same technology to financial professionals and serious investors. The EVA framework allows investors to systematically quantify the economics of a business, bringing new discipline to support their judgment. Inovestor’s research database supports EVA’s use in security analysis for investors, equity research analysts, investment advisors, and portfolio managers. This guide illustrates how EVA can be used to improve fundamental security analysis, therefore enhancing the stock picking process.

Introduction to EVA

EVA is a measure of economic profit created by a company. The higher the EVA, the more value a company is generating for its investors. While the accounting profit, as reported in the North American corporation’s financial statements, considers solely the cost of the debt in calculating the cost of capital of a company, the economic profit as provided by the EVA approach also considers the cost of the equity. The cost of equity is the return that is anticipated by the providers of this equity (the investors), for investments with comparable risk. It is therefore calculated by analyzing the difference between the return on capital generated by a company and its cost of capital which includes the cost of its equity.

EVA Indicators

• Performance Spread: The difference between return on capital (ROC) and cost of capital (COC). A positive performance spread is desired.

• Performance Index: The ratio of ROC to COC. It is a more meaningful indicator when comparing companies of different sizes and in different industries. A performance index greater than 1 is desired, indicating that for every dollar of costs incurred by the company, the company is generating more than $1 in returns.

Measuring Return on Capital

Return on capital (ROC) is a ratio that measures how well a company turns capital (e.g. debt, equity) into profits. It is defined as the net operating profit after tax (NOPAT) divided by the invested capital. A higher ROC is desired and must exceed the cost of capital (COC) in order to generate positive EVA and therefore create wealth for shareholders.

Measuring Cost of Capital

Shareholders require a rate of return on their capital that is equivalent to the risk taken given the investment. Cost of capital (COC) is the weighted average cost of capital including, cost of equity (using the capital asset pricing model (CAPM)), cost of preferred stock, and cost of debt.

The EVA® ScoreCard

The EVA® ScoreCard offers an in-depth analysis on a large universe of North American companie by using EVA-based indicators.

return on capital = net operating profit after tax

invested capital

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The scorecard is divided into five sections:1. General Information2. The SP score3. Key EVA performance indicators4. Key EVA risk indicators5. EVA graphs

SECTION 1: GENERAL INFORMATION

This section contains general information about the company: the sector in which it operates, the current stock price (bid/ask, volume, market cap), market data ratios, and factors exposure.

SECTION 2: THE STOCKPOINTER (SP) SCORE

Inovestor uses a factor-based approach in establishing an SP score for the North American companies (including ADRs). The SPscore is based on two key criteria: the Performance Score and the Risk Score. The Performance Score looks at the value creationh while the Risk Score looks at the company’s valuation, stability, and indebtedness. For example, an economic performance score in the 80th percentile indicates that the company is in the top 20th percentile best performing companies; a risk score of 20 means that the company’s risk is in the top 20th percentile of least risky companies. The investor will therefore be looking for companies showing a high performance score and a low risk score. This section provides the current SP score and the previous quarter’s score to identify if the company is improving or deteriorating.

SECTION 4: KEY EVA PERFORMANCE INDICATORS

This section looks at the main indicators that Inovestor uses to calculate the performance (SP Performance score) of the company.

• Return on Capital (ROC): This metric is calculated by dividing the NOPAT by the invested capital.

• Cost of Capital (COC): The EVA model considers both the cost of debt and the cost of equity when calculating the cost of capital. It’s calculated by using the capital asset pricing model (CAPM) which considers the beta of the company when calculating the cost of the equity and the weighted average cost of debt of the company.

• Performance Spread: The performance spread is the difference between the return on capital (ROC) and the cost of capital (COC). A positive performance indicates a positive EVA.

• Economic Performance Index (EPI): The economic performance index is the ratio between the ROC and the COC. It allows you to compare companies of different sizes and industries. An EPI greater than 1 represents a company that is creating wealth for its shareholders and generating a positive EVA.

• Weighted EVA Change: Measures the change in EVA on a yearly basis. This value is weighted according to the capital invested. The greater the growth, the greater the wealth creation for the shareholders. A positive but decreasing EVA is less attractive than a negative yet increasing EVA.

• Market Value Added (MVA): The difference between the market value of the company and the invested capital. The metric shows how much value the company created or the anticipated value creation by the market.

• Free Cash Flow (FCF): Calculated on a trailing twelve-month period. The FCF represents the amount of cash a company can reinvest either into growth opportunities or to pay out dividends.

Performance Indicators

2018 2019 2020 PCTL

Return on capital 21.8% 15% 21% 98

Cost of capital 9.5% 5% 7% 50

Performance spread

12.4% 32% 45% 65

EVA performance index

2.31 6.45 7.45 98

EVA change (weighted)

42.7% 45% 65% 65

Market value added (MVA)

951.7M 862.1M 1.9B 100

Free cash flow 24.17% 21.56% 28.77% 98

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SECTION 5: KEY EVA RISK INDICATORS

This section presents the main indicators used to calculate the economic risk (SP Risk score) of the company.

• Price/Intrinsic Value (P/IV): This ratio gives us an idea on whether the stock is undervalued or overvalued. The intrinsic value is calculated on a quarterly basis and users can view the IV calculation by heading to the “IV Simulator”. The intrinsic value is calculated on the basis of the discounted cash flow model. When the ratio is greater than 1, we conclude that the stock is overvalued and thus, trading at a premium. On the contrary, when the ratio is less than 1, we conclude that the stock is undervalued and thus, trading at a discount.

• Future Growth Value (FGV): This indicator identifies whether or not the stock is priced fairly. The FGV is the main risk indicator. It is another view on whether the stock is trading at a premium or at a discount. The FGV represents the portion of the total market value (total debt + stocks outstanding * stock price + cash) of the company that is based on speculation of future growth. This is a good way to gauge the market’s anticipation of a company’s growth. Similar to the Price/Earnings(P/E) ratio and P/E diluted. A negative rate translates into a stock trading at a discount and a positive rate means it is trading at a premium usually due to optimistic market views.

• Business Model Stability: Measures the stability of the return on capital (ROC) on a yearly basis. When we notice a fluctuating ROC year over year, signals that the company is not able to generate stable profits. It is also a good indication of the quality of the company’s management.

• Price Variation: This indicator shows the price variation over the 12-month period preceding the publication of the last financial statements.

• Debt Ratio: This ratio is a measure of a company’s indebtedness, which can be used to evaluate the ability to make payments on its current debt as well as the ability to generate funds by contracting new debt, if needed.

SECTION 6: EVA GRAPHS

The EVA ScoreCard shows three graphs that are important in any economic valuation.

1. Price/Intrinsic Value analysis: The intrinsic value is calculated quarterly. Here you have a graphical representation of the trends of both the price and IV. It helps you to determine if the company is undervalued or overvalued according to our IV. It allows us to observe whether the two prices are converging or diverging. This can make it possible to establish a point of buy or sell.

2. EVA, Net Operating Profit: In this graph we can see the trends of the EVA, NOPAT (Profit Net of Operation after Taxes), and the price. Ideally, we would like to see a positive and constantly growing EVA meaning the company is creating wealth for its shareholders.

Risk Indicators 2017 2018 2019 PCTL

P/IV 1,52 1,86 4,20 94

FGV 50% 49% 72% 73

Price variation 13% 12% 12% 4

Debt ratio 49% 46% 60% 80

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3. Future Growth Value: This graphs presents a comparison between the current operation value of the company and the market value. It gives you an idea of the company’s anticipated growth. The green portion represents the value of the current operating value (Last trailing-twelve months NOPAT/COC), and the blue portion represents the absolute FGV (Market Value - Current Operating Value). The sum of the two is the Total Market Value. When the green portion is above the blue portion, it reflects a discount. If the green portion is below the blue portion, this reflects a premium.

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4. The Peers List: This graph presents a performance/risk analysis of comparable peers. It shows both the SP performance and risk scores of 10 companies listed as the closest peers based on the sector and market cap. The performance score is shown along the Y-axis and the risk score is along the X-axis, therefore the further the position is to the right, the lower the risk, and vice versa. From the graph, you can conclude whether or not the company chosen is the best positioned in terms of performance and risk or if there is a better opportunity in the market. We suggest companies located in the upper right corner, which can be interpreted as a company that is less risky and achieves higher performance. To access the EVA ScoreCard of any of the peers, simply click on its ticker on the graph.

5. PfScan: The PfScan uses the economic performance index (EPI) on the Y-axis, a performance metric, and the future growth value (FGV) as a percentage of the market capitalization (EV) on the X-axis, a risk metric, to compare similar companies. Companies above the x-axis are economically profitable (EPI > 1) and companies bellow the x axis are economically unprofitable (EPI< 1). Companies on the right side are trading at discount and companies on the left side are trading at a premium. In summary, we look for companies that are preferably in the top-right quadrant and we should avoid companies in the bottom-left quadrant.

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Main Indicators to Focus On

Amongst all the information that can be used from the EVA ScoreCard, here are the 7 most significant indicators to evaluate the economic performance and risk of a company.

Under “Basic Financial Indicators”:

1. Does the company distribute dividends? Is the dividend-yield positive?• Have the dividends been growing over past 2-5 years?• Are dividends lower than earnings per share? Be cautious with companies who distribute more than their EPS.

Under “Performance Indicators”:

2. Does the company generate a positive EVA? Does it create wealth for its shareholders?• Is the Return on Capital positive? Ideally, it should be over 10%, but it could depend on the sector such as the

Utilities sector which tend to have lower ROC.• Is the Performance Spread positive? It needs to be positive for the company to generate a positive EVA; we

must remember that EVA is the difference between ROC and the COC. The greater the Performance Spread, the better.

• Has the Performance Spread been positive over the past 2-3 years? Ideally, it should be positive and growing; be cautious with companies that have a decreasing spread.

3. Is the invested capital being utilized efficiently? Does it create added value?• Is the Market Value Added (MVA) positive? Ideally, it should be increasing over the years.• Is the MVA at a level where we are satisfied as investors?

Under “Risk Indicators”:

4. Is the stock price undervalued or overvalued? Is the stock overpriced compared to its intrinsic value?• Is the price/intrinsic-value under or over 1? A ratio that is under 1 indicates an undervalued stock while a value

above 1 shows an overvalued stock, compared to its current price.• As investors, we are looking for stocks that carry a P/IV that is lower than 1.

5. Is the stock price artificially inflated by the market due to an over-optimistic forecast of future growth?• Within the risk indicators, is the Future Growth Value (FGV) at an acceptable level? We recommend a value

between -70% and +25%.• Is the FGV growing, meaning that the market price has increased? Or is it falling, meaning that the market

price has decreased? Be cautious with companies with an FGV lower than -70%. It may indicate a value trap.

Understanding the graphs:

6. How does the company’s economic performance and risk compare to its peers? Where is the company located on the peer list?

• Ideally, the higher the SPscore, the better. We recommend a score of 60 or higher.

7. Is the stock price too high?• Using the intrinsic value, has the stock price historically been at a comparable level or has it been too high/

low? In addition, it is important to notice if the price and intrinsic value are moving in the same direction or if they are diverging. A positive signal for investors is when the price and intrinsic value are both increasing/converging.

• As for the FGV, this conveys if the stock is trading at a discount or premium.• In combining these two graphs, we can easily evaluate if a stock is expensive or if it is a bargain.

Now you’re ready to utilize our EVA methodology for yourself!

If you have further questions, we’re always here to help. service@inovestor.com