What Does the Wealth Added Index Mean?
Wealth Added Index (WAI) is a metric designed by Stern Value Management, a consulting firm, that attempts to measure value created (or destroyed) for shareholders by a company.
The consulting firm Stern Value Management invented the Wealth Added Index (WAI), a tool that aims to quantify the value a business creates or destroys for its shareholders. This method of computation states that wealth is produced only when a company’s returns—which include dividends and increases in share price—are more significant than its cost of equity.
Understanding Wealth Added Index (WAI)
The Wealth Added Index’s underlying theory is that since a firm carries a higher level of risk than risk-free products like government bonds, its cost of equity should be higher than the return on such securities (the more significant the chance that investor accepts, the greater the return needed). A company’s stockholders should make another investment if its returns do not outweigh its cost of equity. Put differently, the WAI states that a corporation is decreasing shareholder value if the return is less than the cost of equity and increasing shareholder wealth if the return is more than the cost of equity.
Because it compares returns to the cost of capital, WAI and Economic Value Added (EVA), another Stern Value Management metric, are comparable. Traditional accounting return measurements ignore the cost of capital to generate these returns over a specific period, such as return on equity (ROE) and return on assets (ROA). A corporation may have a high return on equity (ROE); nevertheless, if the cost of capital required to get that ROE was much higher, the company’s value would be compromised.
However, WAI and EVA vary in two important ways. The first and most crucial point about EVA is that it only accounts for outcomes that have already happened. In contrast, WAI considers both the performance of the share price in the past as well as the performance in the future. The current share price of a firm’s stock will represent the likelihood of value creation, or wealth addition, in the future since the equity value of a company is the present value of all future cash flows. Second, since EVA depends on national accounting standards, it cannot provide comprehensive cross-border comparisons. Because various accounting rules are used to determine reported profits, for example, the EVA of a utility firm in the United States and Spain will not be directly comparable. WAI can overcome this restriction by concentrating on the movement of the share price and dividends, which are easily accessible for computation anywhere.
