Beyond Earnings

9THE PERSISTENCE OF CORPORATE PROFITABILITY

There is no more important proposition in economic theory than that, under competition, the rate of return on investment tends toward equality in all industries.

—George Stigler

KEY LEARNING POINTS

• Fade is the rate at which corporate profitability trends towards the mean.
• Fade is the complement of persistence (f = 1 – ρ).
• On average, firms lose 10% of their excess return per year.
• Highly persistent firms fade at half the rate of an average firm. Many of these firms are classified as eCAPs (a subgroup of Stars and Cash Cows).
• Firms in highly cyclical industries often fade at a rate of more than 10% per year.
• By competitive life‐cycle state, Cash Cows are the most persistently profitable, while Dogs are the most persistently unprofitable.

LONG‐TERM REAL RETURN ON INVESTMENT

We have laid the groundwork for measuring corporate performance and recognizing that metrics have their strengths and weaknesses. Return on equity (ROE) is simple to calculate but susceptible to misrepresentation and manipulation. Return on invested capital (ROIC) is a better measure of profitability but still vulnerable to accounting distortions. CFROI takes more effort to calculate but better reflects a firm’s true economic performance.

Superior metrics require considerable attention to maintain because accounting standards are not intended to mirror economic reality; are not globally aligned; are vulnerable to corporate influence; and standards change ...