Tellabs, Inc. (NASDAQ:TLAB) – Good At Destroying Shareholder Wealth

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AFG’s Wealth Creation Report (WCR) is a tool for investors to easily view management’s ability to create wealth for its shareholders, as well as illustrates the high correlation between a company’s Economic Margin (EM) levels and market performance. In the example below you will see a WCR for Tellabs, Inc. (NASDAQ:TLAB) which clearly shows the correlation between EMs and Relative Returns. From 1996 to 2000 Tellabs, Inc. was able to maintain positive EMs and those EM levels were reflected with their ability to outperform the market during this time period. After 2000 however the firms EMs deteriorated and even turned negative causing them to underperform the market since their first major decline in EMs.

The Economic Margin (EM) Framework was developed to evaluate corporate performance from an economic cash flow perspective and is an alternative to accounting-based valuation metrics. EM measures the return a company earns above or below its cost of capital and provides a more complete view of a company’s underlying economic strength.

If you would like to learn more about The Applied Finance Group’s understanding of how management teams create or destroy wealth for their shareholders and how this can help investor’s with their stock selection process...Click Here.

EM is meant to serves two purposes: Create a measure of a company’s economic profitability; that is, did this company generate cash flow in excess of the costs of its capital invested in its operations, or did the company destroy wealth? Once we have solved for this, we can then use this EM as a function in our valuation model.

EM is calculated by dividing a company’s Operating Cash Flow minus Capital Charge by their Invested Capital.

It is not uncommon for companies to grow EPS while having declining or negative EM’s. This occurs when the cost for the investment required to yield the EPS (cost of capital) is more than the cash flow generated from the investment. From an economic perspective, this is growing EPS at the expense of the economics of the business.

Unlike traditional measures, EM considers the “profitability” of EPS growth, eliminates accounting distortions, and are comparable across time and industry. By analyzing a company’s EMs through time, investors gain a more accurate account of levels and changes in a company’s current profitability and value.

Economic Margin Framework Helps Investors…

• Eliminate Buy/Sell errors due to Accounting Distortions

• Captures the Relevant Drivers necessary to Evaluate Corporate Performance.

• Allows for the Comparison of Performance across Companies, Industries, and Time.

• Strong, Systematic link to Market Values.

• Identifies Value Creating Firms.

EM Levels and Market Multiples

• EM levels are correlated with market multiples

• EM changes lead to market value changes

To learn more about AFG’s Economic Margin framework...Click Here

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