Valuation Perspectives - September 23, 2020
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Valuation Perspectives September 23, 2020 CONFIDENTIAL AND PROPRIETARY Any use of this material without specific permission of McKinsey & Company is strictly prohibited
McKinsey & Company 2
Agenda Everlasting - Growth and ROIC drive cash flow and value
New – Digital
Everlasting/New – Long-term orientation wins
New - ESG
Stock market during the pandemic
McKinsey & Company 3
Value creation driven by growth and ROIC
Change in
expectations
Intrinsic value drivers
Return on
invested capital
Total return to
shareholders (TRS)
Cash flow
Revenue
Value
growth
Cost of capital
McKinsey & Company 4
Two companies can create same value with different
combinations of growth and ROIC
1996-2017
Value creation
Growth Value of $1 invested
EBITA, annualized in 1996 ROIC
11% $19 13%
7% $19 29%
McKinsey & Company 5
Agenda Everlasting - Growth and ROIC drive cash flow and value
New – Digital
Everlasting/New – Long-term orientation wins
New - ESG
Stock market during the pandemic
McKinsey & Company 6
New, disruptive business
models
Digital: Two ways to create
value
Doing things better
McKinsey & Company 7
Digital business models – ‘network effects’ still rare
‘Winner takes all’ economics
$
2 Increasing
benefits per
user
3 Sufficient
competitive
barriers
(e.g. switching costs)
1 Decreasing
costs per
user
Number
of users
* ... McKinsey & Company 8
Digital business models may have vastly different economics than
traditional models
. Value Drivers by Business Model
Revenue and Value Split by Business Model
Operating Margin
Sample Company
Marketplace 21.3%
100%
Online Retailer 18.2%
80%
Physical Stores 8.5%
60% Marketplace
Online Retailer
40%
Physical Stores Capital Turnover (including Leases)
20% Marketplace 4.23
0%
Revenue Value Online Retailer 2.42
Physical Stores 1.24
McKinsey & Company 9Use DCF with scenarios
Valuing Fast
Growing
Start from the future
Companies
Weight the value of the scenarios, but
you will be wrong
Multiples can be dangerous
McKinsey & Company 10Four ways digital can create value from doing things better
Improved customer New revenue Better decision
Cost reduction experience sources making
Examples
Predictive maintenance One click purchase Data monetisation Precision customer
Robotic Process 15 min mortgage Subscription targeting
automation (RPA) approval Marketplace Data-driven innovation
McKinsey & Company 11Agenda Everlasting - Growth and ROIC drive cash flow and value
New – Digital
Everlasting/New – Long-term orientation wins
New - ESG
Stock market during the pandemic
McKinsey & Company 12Companies that improve short-term earnings by diminishing their
value proposition destroy long-term value
Context and short-term temptation Long-term consequence
To meet short-term earnings targets, CEO cut front- Stock price plummeted, and customers
Big box
line sales force, reducing headcount and training fled to major competitor
retailer
Industry leader announced investment in novel Despite early advantage, company was
High tech technology ahead of peers, but failed to back it up beaten handily by competitors who
with real capital investment invested more aggressively
Tried to supercharge earnings growth by improving Lost brand equity and had to make
Consumer
gross margins for multiple years in a row major re-investments to catch back up
staples with competitors
Premium fashion company tried to maintain strong Despite initial sales success, eventually
Apparel growth by reducing quality of products and added destroyed its premium perception
large number of outlet stores which diluted brand Alienated core customer base and sales
plummeted
McKinsey & Company 13We identified four behaviors that long-term companies embrace, as
well as three temptations that they avoid
Behaviors to embrace Temptations to avoid
A Investing sufficient capital and talent in large, risky E Starving growth investments due to short-term
initiatives to achieve a winning position challenges, such as temporary earnings deviations
from plans or poor performance in other parts of the
B Constructing a portfolio of strategic initiatives that company
delivers returns exceeding the cost of capital
F Improving earnings by cutting costs in areas essential
to the company’s competitive position, such as
C Dynamically allocating capital and talent – via customer service and R&D
divestitures, if needed – to businesses and initiatives
that create the most value G Artificially reducing the natural volatility in revenue
and earnings
D Generating value for employees, customers, and
other stakeholders, as well as shareholders
McKinsey & Company 14Achieving a long-term orientation requires action from the board
and the top management team
Seven steps towards a long-term orientation
Long-term 1 Ensure strategic investments are fully funded each year and have the appropriate talent assigned to them
boards of
directors…
2 Evaluate the CEO on the quality of strategy and its execution, company’s culture and the strength of its management
team – not just financial performance
3 Structure executive compensation over longer time horizons – including time after they leave the company
Long-term 4 Personally ensure strategic initiatives are funded properly, staffed properly, and protected from short term earnings
CEOs/ pressure
executives…
5 Adapt their management system to encourage bold risk taking and eliminate biased decision making
6 Proactively identify and engage long-term investors – and have the courage to ignore short-term shareholders and
other members of the investment community
7 Demonstrate the link between financial and non-traditional metrics to avoid short term tradeoffs
McKinsey & Company 15Agenda Everlasting - Growth and ROIC drive cash flow and value
New – Digital
Everlasting/New – Long-term orientation wins
New - ESG
Stock market during the pandemic
McKinsey & Company 16Five ways that ESG creates value
1 Top-line Sustainable products
growth
2 Cost Energy efficiency/water usage/packaging
reduction
3 Regulatory License to operating/regulatory hurdles
relief
4 Productivity Employees with sense of purpose stay longer and more productive
uplift
5 Investment/ Investment in new technologies/avoiding investments that may be stranded
CAPEX
McKinsey & Company 17Long-term companies link financial and non-traditional metrics to
prevent short term tradeoffs
Companies should focus on the Each company must decide their own non-
most material metrics traditional metrics that are core to their business
Illustrative – Not Exhaustive
Companies should make investments and Company metrics
report based on the metrics that are core to
their business Chemical Carbon emissions
company Plastic production
Combining both financial and non- Safety incidents
traditional metrics prevent short term
tradeoffs that compromise long term
strategy Apparel Supply chain working conditions
company Living wages in supply chain
Use of recycled raw materials
Beverage Water usage
manufacturer Plastic usage
Added sugar in products
Source: “Investors and Companies Can Drive ESG Metrics Forward Together” (2020) from FCLT; “Driving the Conversation: Long-term Roadmaps for Long- McKinsey & Company 18
Term Success” (2019) from FCLT; “Corporate Sustainability: First Evidence on Materiality”Agenda Everlasting - Growth and ROIC drive cash flow and value
New – Digital
Everlasting/New – Long-term orientation wins
New - ESG
Stock market during the pandemic
McKinsey & Company 19The COVID stock market – it is still about the long term
Bae scenario Crisis Scenario 1
160
140
120
Earnings
100 Even significant
decline short-term
50% 80 earnings decline
has limited
60 Value impact impact on market
value
40 ~ -10.0%
Recovery time
20
2 yrs
0
2020 21 22 23 24 25 26 27 28 2029
McKinsey & Company 20US stock market composition different than real economy
Percent
100 100
37 37
Other
0
4
1
Real estate/construction 20 12
11
Professional and technical services 16
Healthcare services 9
Banking, Insurance and 35
other financials 9
Pharma & Medical Products 1
Technology, Media and Telecom 8
Contribution to GDP Percent of Market Cap1
1. Largest 1000 US companies, as of September 15, 2020
Source: S&P Global, Corporate Performance Analytics McKinsey & Company 21TMT has become the largest sector in the US stock market over the
past 25 years; it now accounts for 35% of the market
Share of industries as percent of total market cap, top 1000 US companies
100 100 100
Other 18 20 18
Oil & Gas 7 2
4 3
Conglomerates 6 3 5
4
Retail 5 8
8
9
Consumer Goods 19 11
10
10
Banking & other financials 8 11
Pharma & Medical Products 10 10
Industrials 14
35
29
Tech, Media & Telecom 14
Jan 1, 1996 Jan 1, 2020 Sep 15, 2020
Source: S&P Global, Corporate Performance Analytics McKinsey & Company 22Mega-caps driving US stock market returns since January 1
Share of industries as percent of total market cap, top 1000 US companies
Year-to-date TSR1
100 100
Other 20 18
Oil & Gas 2
4 3
Conglomerates 3 5
4 8
Retail + 0%
8
Consumer Goods 9 + 3%
Financials 11
10 + 9%
Pharma & Medical Products 10
11
Industrials 10
Other Tech, Media &
14 + 18%
13
Telcom
Tech, Media
& Telecom Apple, Alphabet, Amazon, 21 + 43%
16
Facebook, Microsoft
1. Total shareholder returns Jan 1, 2020 Sep 15, 2020
Source: S&P Global, Corporate Performance Analytics McKinsey & Company 23Impact of handful of large companies on aggregate P/E ratios
Median and average P/E ratios, large US companies, FY+2
AS OF SEP 4, 2020
Median
17 17
16 16 16
15 16 15
15
14 13 13
13 13
12
10
2005 06 07 08 09 10 11 12 13 14 15 16 17 18 19 2020
Weighted 21
Average 17 17
15 16
15 15
14 14 13
13
12 12 12
11
10
2005 06 07 08 09 10 11 12 13 14 15 16 17 18 19 2020
Source: Corporate Performance Analytics, S&P Global McKinsey & Company 24You can also read
