Calculating a company’s relative performance … is not straightforward, and for at least two reasons. First, we wish to capture the performance of the company that is a function of those factors most subject to the company’s control. When it comes to assessing a company’s historical performance, we typically wish to separate out the material impact that year, industry, and company size have on profitability. Dealing with unadjusted ROA numbers confounds the quality of management with the good fortune of having operated during expansionary times, the foresight to have chosen a good industry, or the compounding effects of a stroke of good luck early in the journey.
Once we choose to understand a company’s performance contingent on these factors, we run into our second challenge: the vanishingly small set of companies against which we can benchmark another company. After all, if we insist on comparing only like with like, we can easily end up with but a handful of companies to compare with each other. Notions of 50th, 75th, and 90th percentile performances break down quickly under such conditions. In a small sample, the relative standing of a given absolute level of performance can be artificially inflated, leading to complacency, or artificially depressed, leading to exhausting and fruitless efforts to fix problems that don’t exist.
Authors: Michael E. Raynor, Mumtaz Ahmed, Rob Del Vicario
Source: Deloitte Review
Subjects: Finance, Management
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