I will apply real world application to the problems with NPV, sunk cost and EPS that I mentioned in my last blogs. I want to focus on two companies that I have studied in my past: Toys R US and Berkshire Hathaway.
Real World Applications of Valuating Innovations and EPS (Blog 6)
1. Toys R Us fell victim to sunk costs and the concept “To make money you have to spend money” when deciding not to innovate their business model online.
2. Warren Buffet and his company, Berkshire Hathaway, care a lot about their reputation so they purposely manipulate their EPS by repurchasing shares instead of using excess money for innovation.
Toys R Us was created in 1948 and dominated the toy market in the 1980s and 1990s. Although, the rise of mass merchants caused Toys R Us to lose share in toy market and fall behind Walmart in Toy Sales in 1998. They had a decision to innovate and try to digitize their business or continue focusing on in-person transactions. Because of the short term loss they would’ve had and fear of not being able to recoup the sunk loss of going digital, they decided to stick to their guns. When they realized the entire world was relying on online shopping, it was too late to introduce new technologies. Their failure to innovate allowed competitors (Walmart, Ebay, Target, etc.) to step up and eventually caused them to go bankrupt. This is why the losses shown on NVP analysis may hurt some companies and cause them to underinvest, or not invest at all in T.R.U.’s case, in future technologies.
Berkshire Hathaway is a conglomerate that wholly owns firms in industries such as insurance, railroads, and retail. Its stock has the reputation of being a valuable stock and the most expensive stock in the market. Buffet is known for being particular about who has share in his company which is why one share costs over $382,000. (Red Flag) While the company performed well during the pandemic, it did not outperform its 2019 values. Although, their income/profits weren’t as high in 2020, their EPS, which is Income divided by total shares, was higher. This is due to the fact that the company spent $15.7B is share repurchases in 2020. By doing so, it increased EPS and shareholder value by having less shares in the market. While this was a good decision for Berkshire, it shows that EPS can be manipulated and isn’t a great metric for how a company is doing overall.