Tired of anecdotal accounts of management performance? Or cherry-picked management studies? Or self-serving claims by managers and consultants of successful turnarounds?
Then look no further than the 5-Year Total Return (5YTR). It helps measure aspects of a public firm’s performance. Examples of its usefulness were included in my last article. This article offers more on its function, strengths and limitations.
Thus, the 5YTR is not just another useful gadget. It can shed light on how the fastest growing firms today are being run very differently from average performing firms. “Management has been upended,” said Business School Professor of Leadership, Tammy Erickson recently at a Drucker Forum session. A management paradigm shift of the kind envisaged by Thomas Kuhn appears to be under way. In 2024, it’s not only time, as Peter Drucker suggested to “look out the window and see what’s visible—but not yet seen.” We also need to change the way we think about and measure performance. The 5YTR can help solve the puzzle.
The 5-Year Total Return (5YTR) is a ratio calculated as follows:
In its numerical form, it is a percentage.
In its graphical form, the 5YTR shows how the stock market’s perception of the value of the stock has changed over the years.
A similar formula can calculate and picture the 10-year or 20-Year Total Return, if an even-longer-term perspective is desired.
The long-term total return (LTTR) of a public firm is composite measure of the stock market’s collective judgment that draws on:
· the perceived rate of value creation over the previous years,
· the efficiency of that value creation, and,
· a prediction as to the value that the firm will create in future.
The 5YTR is a gestalt generated by the active players in the stock market on a continuing basis over the previous 5 years. Although the 5YTR cannot be broken down into different components, separate indices are available to measure other dimensions of performance as needed.
The 5YTR is not just another opinion. In a capitalist economy, the stock market participants collectively assign a stable, rising, or falling, price to each public firm for the future. These price decisions are a set of societal decisions that largely determine whether a firm can acquire additional resources to do more, or alternatively, to suffer financial sanctions for perceived performance shortfalls.
The stock market thus functions as a “societal determinator” of public companies. Although investors may be pursuing their own self-interest and short-term gains, and stock prices can fluctuate wildly in the short-term, the collective actions of multiple “bullish” and “bearish” investors over time can result in relatively stable public valuations over time. The functioning of the 5YTR illustrates Adam Smith’s “invisible hand” in The Wealth of Nations: self-interest can result in public welfare.
The 5YTR has obvious strengths and limitations.
1. The Stock Market Draws On A Cornucopia Of Supporting Evidence: Public firms provide a vast array of audited financial, performance, and conversational data on a quarterly basis. Firms obviously seek to portray their activities in the best light, while analysts collectively seek to uncover hidden advantages or flaws. Civil and criminal penalties are applied for providing misinformation. Differing viewpoints, pro and con, are freely available.
2. The 5YTR Exemplifies ‘The Wisdom Of Crowds’: The 5YTR is a measure that reflects the collective judgment of investors, As James Surowiecki’s argues in The Wisdom Of Crowds, groups are often smarter than the smartest individuals in them. The 5YTR has all the elements of useful crowd intelligence, including diversity of opinion, documentation of alternative viewpoints, independence of decision-makers, access to specialized and local knowledge, auditing of key input information, decentralization of judgments, an aggregating mechanism for collective decision-making, and a real interest in the outcome.
3. The 5YTR Captures Flow And Momentum, Not Just Snapshots: The graphical representation of the 5YTR helps uncover important performance trends. It looks beyond short-term ups and downs of the stock price. Seemingly abrupt declines or startling rises in value, or shifts in the economic context, can be seen in a clearer perspective.
4. The 5YTR Builds On ‘Exchange Value’ For Customers:: A key element in the valuing of stocks include earnings, hence sales, and ultimately the value that customers see in a firm’s products and services.. The 5YTR reflects in part the “exchange value” by which the customer’s subjective value becomes objective through the mechanism of willingness to pay. Customer perspectives can also be verified other methods, particularly sales data.
5. The 5YTR Enables Comparisons Between Firms Of All Sizes: it compares compare the performance of giants like Apple and Microsoft as well as tiny firms like Signet Jewelers or e.l.f. cosmetics.
6. The 5YTR Can Be Applied Globally: Thus “Blue Chip” European firms show the same split in performance as U.S. firms showed in my last article.
7. The 5YTR Is Continuously Updated on tens of thousands of companies, their products and services and their customers.
8. The 5YTR Is Widely Accepted. Although infrequently referred to in management or academic writing, the 5YTR is widely used in the financial world.
9. The 5YTR Is Free And Easy To Use The information is available instantly and doesn’t require additional work. The information is available free of charge.
The 5YTR’s main drawbacks as a measure include:
1. The 5YTR Is Necessary, But Not A Sufficient, Condition Of Success. It is useful summary as a starting point for analysis, not a final measure of success. Other dimensions need to be examined.
2. The 5YTR Prioritizes The Viewpoint Of Shareholders: It prioritizes viewpoint of investors and shareholders, ahead of employees and society. However as 58% of US households now own shares in the stock market and that percentage is steadily increasing, financial literacy is itself an issue of increasing public concern.
3. The 5YTR Covers Customer Value Indirectly Rather Than Explicitly: It is not a direct measure of customer value. It can be pursued separately by considering sales.
4. Big Players Have A Greater Say Than Small Players: Big players have more money at stake but often make more effort into making the best decision. If their judgements are wrong, they in turn suffer the consequences.
5. The Use Of The 5YTR May Facilitate Share Buybacks And Egregious Executive Compensation. Executive compensation is way out of line. $5 trillion in stock buybacks is a huge distortion in U.S. firms.
6. The 5YTR Doesn’t Eliminate Scams. Even though the 5YTR builds on a huge repository of audited data, cases of massive fraud like Enron or FTX do occur, but they are rare,
7. The 5YTR Follows A Period Of Aberrant Capitalism. The last half-century has been a period of aberrant capitalism. Nevertheless, the 5YTR can help navigate through those aberrations.
8. The 5YTR prioritizes growth: For some critics, growth is the problem, not the solution.
There are many alternatives to the 5YTR, none of them very satisfactory by themselves, including:
· Anecdotal accounts are essential supplements to data but cannot replace data.
· Indices such as sales revenues are closer to the customer viewpoint but don’t permit comparisons between firms of different sizes or measurement of the efficiency of delivering sales.
· Surveys such as the Net Promoter Score depend on who is surveyed, and why, as well as the survey’s underlying agenda.
· Rating agencies also depend on surveys and private ratings.
· Financial models like CF-ROIC depend on many internal assumptions as well as on business models that may now be obsolete.
Just as democracy is often said to be the worst form of governance except every other form that has been tried, so the 5YTR might be the worst single measure of performance of public firms, except for every other measure that has been tried.
The 5YTR is a fact of life. Use it—or ignore it—at your peril.
And read also:
The Management Paradigm Driving The World’s Most Valuable Firms