[ read time: 4 minutes ]
While there are a number of factors that impact the share price of a company, the two basic drivers remain earnings (or profit) and the multiple applied to earnings.
Two companies with the same profit, working in the same overall environment, frequently have different multiples; these multiples dramatically impact the value of the company and therefore the share price.
For example, a company with a $10,000,000 profit and a multiple of 5 times earnings receives a $50 million valuation, while another company with the same profit and a 7.5 times multiple has a value of $75 million.
While many companies focus on increasing profit, and therefore shareholder value, relatively few focus the same effort on improving their multiple. So, what drives this multiple?
The first driver is economic expectations. If the economy is deteriorating, even though profits have not yet fallen, share prices will drop and multiples retract on expectations of leaner times. Despite the fact that this is outside of management's direct control, it is important to note that some companies do not drop as significantly as their counterparts.
This is due to the influence of the second driver, corporate expectations. These expectations are a function of the company's ability to lead the industry. Proven leaders typically have higher multiples than others in the same industry, regardless of economic expectations. One of the key leadership criteria is whether or not a company has a sustainable competitive advantage.
So if a company's compensation plans strengthen the company financially, increasing profit immediately and protecting earnings in a downturn, it would provide such a sustainable advantage.
Such a solution does exist today and has stood the test of time. It is particularly effective when the primary distribution channel is through people whose skill is key in binding the consumer to the company. Examples range from industries that use a typical sales force, like real estate and manufacturing, to professional service organizations, such as law firms and dental offices.
The companies that have used this bold new approach have experienced increased productivity from their existing staff and improved ability to recruit key revenue providers from their competitors. They typically have seen an immediate increase in profit and have been able to retain their lead even after competitors copied their strategy.
The essence of the approach is:
1. Design compensation plans so that after the company has recovered its costs plus a profit from each revenue-producing individual, those individuals can then receive substantially more of the revenue they bring in.
This drives productivity and immediately increases profit. It also creates a naturally cost-efficient environment and improves recruiting.
2. Offer choices that empower the individual to find the right compensation fit; usually this involves selecting the risk-reward relationship that works best for each revenue-producer.
This maximizes recruiting and retention and lowers the breakeven point of the company, increasing its survivability and maintaining profitability, even in a downturn.