Wealth Added Index (WAI): What it Is and How It Works
Definition
The Wealth Added Index (WAI) is a measure developed by Stern Value Management to assess whether a company is creating or destroying shareholder value. It compares total shareholder returns (share price gains plus dividends) with the company’s cost of equity. If returns exceed the cost of equity, the company is said to be adding wealth for shareholders; if not, it is destroying wealth.
How WAI Works
- Cost of equity reflects the return investors require to compensate for risk. It should generally exceed the return on risk‑free securities (such as government bonds) because investing in a company is riskier.
- WAI evaluates whether the company’s realized and expected returns justify that required return. A positive gap (returns > cost of equity) indicates value creation; a negative gap indicates value destruction.
- WAI uses market data—share price changes and dividends—so it incorporates investors’ expectations about future performance as reflected in current price.
WAI versus Economic Value Added (EVA)
Both WAI and EVA compare returns with the cost of capital, but they differ in two important ways:
– Forward‑looking vs. backward‑looking: EVA is typically backward‑looking (based on historical accounting results). WAI incorporates market prices and dividends, capturing both past performance and market expectations of future cash flows.
– Cross‑border comparability: EVA depends on accounting measures that vary across jurisdictions, which can hinder international comparisons. WAI relies on market prices and dividends, which are more consistently available across countries and sectors.
Why It Matters
- Investor relevance: WAI focuses on outcomes that matter to shareholders—market value and cash returned as dividends—rather than accounting profits alone.
- Performance signal: It helps identify companies that genuinely earn returns above the cost of equity, signaling sustainable value creation rather than merely high accounting returns.
Simple Example
- Cost of equity: 8%
- Total shareholder return (price change + dividends) over the period: 12%
- Interpretation: The company generated returns 4 percentage points above the cost of equity, indicating wealth was added for shareholders over that period.
Limitations and Considerations
- Market dependence: Because WAI uses share prices, it can be influenced by market volatility, sentiment, and short‑term speculation.
- Estimating cost of equity: Accurately calculating the cost of equity requires assumptions (e.g., beta, risk premium) and can vary across models.
- Not a complete valuation metric: WAI is a useful indicator of shareholder value creation but should be used alongside other financial and operational analyses.
Key Takeaways
- WAI measures whether shareholder returns exceed the company’s cost of equity.
- It is forward‑looking and market‑based, making it useful for cross‑border and investor‑focused comparisons.
- Positive WAI indicates value creation; negative WAI indicates value destruction.
- Use WAI together with other metrics and careful cost‑of‑equity estimation to evaluate corporate performance.