Do the best: Performing Serbian companies create value?

Abstract

All investors expect to earn a return on invested capital in accordance with investment risk. With respect to the degree of exposure to risk, shareholders are in the most unfavorable position in comparison to all other stakeholders. Given that shareholders' return is closely related to net income, as it represents the residual which remains after the interests of all other stakeholders have been meet, it is obvious that there is a risk that they might not get any return in situations where there is no income or it is not sufficient to compensate for the existing risks. In this context, from the perspective of value creation management the ultimate responsibility of a company's management is to create value for all stakeholders, including shareholders. With the aim of satisfying the interests of shareholders it is necessary to raise the performance threshold to the level of net income that would be sufficient to cover the opportunity costs of equity. Only then can we say that companies are really profitable and that each of them whose income exceeds this level (at which the total costs of capital are covered) creates value added. The value creation imperative is of particular importance in the Serbian economy, considering that over the entire analyzed period, on average, 34.4% of companies reported losses, 8.4% of companies had income that was equal to zero, while only 57.2% of the total number of companies reported net income. In such circumstances, there is a tendency for every company that reports net income to be labeled as profitable. However, it makes perfect sense to raise the question as to whether all the companies which report net income create value. In this paper we analyze the 89 most profitable companies in terms of the amount of net income. The relevance of the research arises from the fact that these companies generated more than 45% of total net income of the economy in 2013. In the first part of the paper we present the business and financial profile of the Serbian economy in order to provide a general understanding of the financial problems faced by most companies. In the second part we explore the key determinants of profitability with a view to identifying the key value drivers and their impact on the level of profitability. In the third part of the paper the performance of the best Serbian companies is assessed from the standpoint of their ability to create returns to shareholders by applying residual income as the main criterion. Such an approach has enabled us to differentiate companies and sectors in terms of their capacity to create value added as well as to detect the companies that are responsible for the destruction of value.