Valuation, 7th Edition

1Why Value Value?

The guiding principle of business value creation is a refreshingly simple construct: companies that grow and earn a return on capital that exceeds their cost of capital create value. Articulated as early as 1890 by Alfred Marshall,¹ the concept has proven to be both enduring in its validity and elusive in its application.

Nevertheless, managers, boards of directors, and investors sometimes ignore the foundations of value in the heat of competition or the exuberance of market euphoria. The tulip mania of the early 1600s, the dot-coms that soared spectacularly with the Internet bubble, only then to crash, and the mid-2000’s real estate frenzy whose implosion touched off the financial crisis of 2007–2008 can all to some extent be traced to a misunderstanding or misapplication of this guiding principle.

At other moments, the system in which value creation takes place comes under fire. That happened at the turn of the twentieth century in the United States, when fears about the growing power of business combinations raised questions that led to more rigorous enforcement of antitrust laws. The Great Depression of the 1930s was another such moment, when prolonged unemployment undermined confidence in the ability of the capitalist system to mobilize resources, leading to a range of new policies in democracies around the world.

Today many people are again questioning the foundations of capitalism, especially shareholder-oriented capitalism. Challenges such as globalization, ...