Economic Value Added

When it comes to trading, certain terms are crucial to understand. One such term is Economic Value Added, often abbreviated to EVA. This concept is a key part of financial analysis used by investors and traders. But what exactly is Economic Value Added, and how is it relevant to trading?

Defining Economic Value Added

Economic Value Added is a measure of a company's financial performance. It is based on the concept that businesses should create returns at a rate above their cost of capital. EVA is calculated by subtracting a company's capital cost from its net operating profit after taxes (NOPAT).

In practical terms, if a company's EVA is positive, it's creating shareholder wealth. If it's negative, it's destroying shareholder wealth. Simply put, EVA gives a real picture of how much value a company is generating for those who've invested in it.

How is Economic Value Added relevant to trading?

Understanding EVA is useful for investors and traders as it provides an insightful measure of corporate performance. It's not just about how much profit a company generates, but about the economic value it adds – hence the name.

The fact that EVA factors in a company's cost of capital means it takes account of the risk associated with investment. This is a crucial aspect for traders eyeing potential investment opportunities. A positive EVA figure can signal a good pick for investors, pointing towards a company that's effectively managing its capital and generating returns.

Calculating Economic Value Added

Even though EVA is a complex concept, its calculation can be simplified as follows:

EVA = NOPAT - (Capital Invested * Cost of Capital)

The cost of capital here refers to the return expected by investors for bearing the risk of investing in the company.

Understanding EVA can be a powerful tool for trading. It provides invaluable insight into a company's financial health, going beyond the usual financial metrics. For informed investment decisions, savvy traders often turn to Economic Value Added.