INVESTING IN VALUE BASED MANANGED COMPANIES

Value Aligned Investing Study Hypothesis

Does a stock selection strategy based on companies that adopt a Value-Based Management (“VBM”)
program such as Economic Value Added (“EVA”) produce superior risk-adjusted returns? Rapidan’s
Value Aligned Investing philosophy holds that a public commitment to VBM by a management team who
has been unwilling, unmotivated or unable to address issues that are within its control, triggers tactical and
strategic changes that increase shareholder value. In this study we test whether a portfolio of VBM
adopters who publicly commit outperform popular benchmarks like the S&P 500, NASDAQ and Russell
2000.
Value of $1,000 Invested in Value Aligned Long Only Portfolio vs.
S&P 500, NASDAQ and Russel 2000 (1988 - 2002)

$14,000

$12,000 Value Aligned

$9,296
$10,000

$8,000
S&P 500
$5,095
$6,000
NASDAQ
$4,041
$4,000

Russell
$2,000 2000
$3,181
$0
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Portfolio S&P 500 NASDAQ RUSSELL 2000

Description of the Study

We used two sources to identify the VBM adopting companies (“Value Aligned Portfolio”) and when they
first committed to their programs. Primarily, we used the list of former and current Stern Stewart & Co.1
clients as published in its research entitled “EVA Works II”. We also searched through quarterly and annual
SEC filings contained in the EDGAR database. The Value Aligned Portfolio was weighted equally and
rebalanced monthly. Equally weighting the portfolio eliminated “back-ward looking” style or factor bias
(valuation, sector and/or size). Monthly rebalancing allows for the addition of those companies beginning a
VBM program and allows for the subtraction of companies that may no longer trade (i.e. acquired). After
we added a company to the portfolio, we held it through December 2002. We chose the period 1988-2002
to make sure we studied the Value Aligned Portfolio performance during bull and bear markets and
economic periods of expansion and contraction.2
Value-
Period From Aligned RUSSELL 3-Month
2 2 2
December 2002 Portfolio S&P 500 NASDAQ 2000 T-Bill
CAGR Return
15 Years 16.0% 11.5% 9.8% 8.0% 4.9%
10 Years 13.6% 9.3% 7.0% 5.7% 4.3%
7 Years 11.8% 6.9% 3.5% 2.8% 4.3%
5 Years 5.3% -0.6% -3.2% -2.6% 4.0%
3 Years 2.9% -14.5% -31.0% -8.8% 3.5%

Table 1. Summary Annualized Returns for Long Only Value Aligned Portfolio Results For
Periods Ending December 2002.

1
Stern Stewart & Co. is a global consulting firm that specializes in the design and implementation of EVA programs in companies
throughout the world. For more information and a list of Stern Stewart clients go to www.eva.com.

125 Half Mile Road, Suite 200 • Red Bank, New Jersey 07701 • (732) 933-2727
Results of the Study
The average number of companies in the portfolio since inception was 39 beginning with two companies in
1988 and ending with 77 companies at the end of 2002. The largest increase in companies added to the
portfolio was 17 in 1994 followed by increases of 11 companies in each of the following three years. The
Value Aligned Portfolio was compared to the benchmark indices over five multiyear periods; three, five,
seven, ten and fifteen year portfolios. Tables 1 and 2 compare the returns of the Value Aligned Portfolio to
the returns of the benchmarks. The Value Aligned Portfolio, in addition to outperforming each benchmark
both in annualized returns, outperformed the benchmark indices in nine of the fifteen years. The Value
Aligned Portfolio has a better reward-to-risk profile as measured by the Sharpe Ratio, while experiencing
only two years of negative performance versus four years for the S&P500 and five years for the NASDAQ
and Russell 2000.
Table 2. Long Only Value Aligned Portfolio Results and Summary Statistics (1988 – 2002).

# OF VALUE RUSSELL 3 MONTH

COMPANIES YEAR ALIGNED S&P 5002 NASDAQ2 20002 T-BILL
2 1988 16.4% 16.6% 15.4% 22.4% 6.7%
5 1989 47.0% 31.6% 19.3% 14.2% 8.1%
7 1990 -10.8% -3.1% -17.8% -21.5% 7.4%
8 1991 54.5% 30.4% 56.8% 43.7% 5.3%
10 1992 10.2% 7.6% 15.5% 16.4% 3.4%
11 1993 16.5% 10.1% 14.7% 17.0% 3.0%
28 1994 2.6% 1.3% -3.2% -3.2% 4.3%
39 1995 37.0% 37.5% 39.9% 26.2% 5.5%
50 1996 22.5% 22.9% 22.7% 14.8% 5.0%
61 1997 37.7% 33.4% 21.6% 20.5% 5.1%
64 1998 9.4% 28.6% 39.6% -3.4% 4.8%
70 1999 8.6% 21.0% 85.6% 19.6% 4.7%
74 2000 3.2% -9.1% -39.3% -4.2% 5.8%
75 2001 20.6% -11.9% -21.1% 1.0% 3.3%
77 2002 -12.4% -22.1% -31.5% -21.6% 1.6%

Total Holding Period 829.6% 409.5% 304.1% 218.1% 105.5%

CAGR 16.0% 11.5% 9.8% 8.0% 4.9%
Standard Deviation 19.6% 18.6% 33.7% 17.9% 1.7%
Down Years 2 4 5 5 -
% Years Outperformed - 60% 60% 73% 73%
Sharpe Ratio 0.57 0.35 0.14 0.17

Conclusion
VBM is generally thought of as a tool for managing the internal operations of a business in ways that are
thought to create shareholder value. While many stock analysts and some portfolio managers have adopted
the basic precepts of EVA to assess both the magnitude and sustainability of returns, none systematically
invest in VBM companies. Still, many adopting companies have believed that investors favor companies
that publicly commit to VBM as the number of public commitments in the 1990s demonstrates. We
present evidence that suggests the presence of a value alignment factor that can be exploited if the investor
identifies “aligned and motivated” firms. This result adds to the evidence presented by Kleiman (1999),
Stewart, Ellis and Budington (2002) and Hackett Best Practices in the Shareowner Alignment Index “Book
of Numbers” (2001) that the stock market performance of value aligned companies is significantly better
than competitors and the market.3

2
Return data sourced from the Compustat database. The S&P 500 includes reinvested dividends. The NASDAQ and Russell 2000
exclude reinvested dividends.
3
See Robert T. Kleiman “Some New Evidence on EVA Companies.” Journal of Applied Corporate Finance 12(1999):80-91. G.
Bennett Stewart, III, Martin Ellis and Daniel Budington “Stern Stewart’s EVA Clients Outperform the Market and Their Peers.”
EVAluation: Special Report (October 2002) www.eva.com. Hackett Best Practices, “Shareowner Alignment Index: Book of
Numbers”, (2001) www.saisurvey.com.
*
Search criteria included “EVA”, “Economic Value Added”, “EP”, “Economic Profit”, “VBM” and “Value Based Management”. In
addition, companies using any of these criteria as a primary performance measure are included in the portfolio.

125 Half Mile Road, Suite 200 • Red Bank, New Jersey 07701 • (732) 933-2727