METI's "Growth Investment Guidance" is fantastic!

AK0276 (Slightly updated on August 2nd)
Recently, economic media outlets have begun citing the "Growth Investment Guidance published by METI in July."

Growth Investment Guidance was published by METI on July 21st and can be obtained from the following links.
Document 1 Growth Investment Guidance (75 pages)
Document 2 Growth Investment Guidance Executive Summary (11 pages)
Document 3 Growth Investment Guidance Data Collection (Excerpt Version) (25 pages)
Document 4 Growth Investment Guidance Data Collection (83 pages)

This content is fantastic!

In the past, the Ito Report focused on ROE, requesting that companies improve their ROE by stating that ROE exceeding the cost of shareholders' equity is a condition for corporate value creation.
In this Growth Investment Guidance, Economic Profit (EP) is set as the core concept of value creation, and it requests that companies improve their ROIC by stating that ROIC exceeding WACC is a condition for corporate value creation.
The Growth Investment Guidance explains EP as follows. (p.3 of Document 2)

The Growth Investment Guidance discusses corporate value creation with this EP as its core (framework). You might think, "The authorities are bringing up new indicators again!", but EP and ROIC spread (ROIC - WACC) are standard methods that are always introduced in serious corporate valuation books.

The amount of value creation calculated from "ROE - cost of shareholders' equity" and the amount of value creation calculated from "ROIC - WACC" are the same if measured correctly.

In the Indian fable "The Blind Men and the Elephant," even if the person touching the ear says it's "like a large fan," the one touching the leg says it's "like a thick pillar," and the one touching the torso says it's "like a large wall," it is still the same elephant.

Regarding corporate value creation, looking at the balance sheet from the right side (from the funding side) is ROE and the cost of shareholders' equity, and looking at it from the left side (from the asset side) is ROIC and WACC. The amount of corporate value creation must be the same whether viewed from the right or the left.

It has recently become well known that if the ROE spread (ROE - cost of shareholders' equity) is positive, PBR > 1, and if it is negative, PBR < 1.ROIC spread is the same; if positive, PBR > 1, and if negative, PBR < 1. Conversely, if PBR < 1, it is a reflection of ROIC < WACC, meaning the company is not meeting the minimum expectations of investors and is causing value destruction on invested capital.

From the perspective of employees working on the front lines of the company, the company-wide ROE and cost of shareholders' equity feel distant and not relatable to their own activities. On the other hand, the invested assets that form the premise of their activities and the rate of profit generated from them (ROIC) are more familiar, evoke a concrete image, and are worth the effort. In that sense, the combination of ROIC and WACC is preferable as a corporate value creation indicator.

There are already listed companies that use such EP as a practical management guideline. One example is Pigeon. Please take a look at slides 34-36 of the financial results briefing materials used at the "Q2 Briefing for Institutional Investors and Analysts" held on August 7th of this year. The company calls EP 'PVA' (which I believe stands for Pigeon Value Added) and defines PVA = NOPAT - Invested Capital × WACC. Furthermore, they break down NOPAT and invested assets into factors to link them to on-site activities.

Although it may not be mentioned (or perhaps it is, but not emphasized) in this guidance, in reality, there is an ROIC and a cost of capital for each business (which corresponds to WACC but is not WACC; it is an unlevered cost of equity that varies by business), and the difference between them is directly linked to value creation. It is necessary to allocate businesses to be expanded or to be downsized/exited based on the magnitude of Business Invested Assets × (Business ROIC - Business Cost of Capital). The weighted average of the cost of capital for each business is the company-wide WACC. For each business, to judge whether value is being created, using the company-wide WACC as the cost of capital is a mistake, and the cost of capital for that business (unlevered cost of equity) must be used. Note 1)

Companies led by employees and managers who can implement the content of METI's growth investment guidance into on-site business activities, executive officers and CFOs who understand the key points of the guidance and can oversee on-site value creation, and CEOs who understand the essence of the key points are the ones who can efficiently create corporate value. CEOs and CFOs who have never heard of terms like EP or WACC, or who get a headache when they hear them, have no future in their companies.

That is all. (End)

Note 1) Regarding this point, please see the explanation of 'Chart 2: Risk and Cost of Capital' in Tomio Arai, 'Cost of Capital and Corporate Valuation Series [Part 1]: What is Cost of Capital?', Securities Analysts Journal, July 2019 issue.