Through its strategic decisions, corporate management can often create, transfer or destroy shareholder value. A classic example is Levitz Furniture Corporation, whose “warehouse-showroom” concept of furniture retailing enabled it to save costs in purchasing, selling, handling and transporting merchandise.
By passing a portion of the benefits of its superior cost structure on to consumers, Levitz attracted a heavy flow of customers willing to purchase furniture on a cash basis and forego free home delivery. With an unusually high inventory turnover and reduced investment in accounts receivable, Levitz was able to generate a significantly higher sales/assets ratio than its competitors. As a result, Levitz was able to earn a rate of return that exceeded its cost of equity capital, successfully creating value for its shareholders.
By 1973, Levitz’s rapid growth in earnings per share had raised the price of its stock well above both its book value and its rational economic value. Levitz’s heady price-earnings multiple represented, not only a resource whereby the company could finance its own future growth very cheaply, but also a value-transfer opportunity for its shareholders, who could profit from the overvaluation by selling out.
Had Levitz maintained its earnings per share growth, the overvaluation might have lasted until the firm was in a powerful competitive position. Unfortunately, Levitz dissipated its opportunity by attempting to meet potential competitors in every local market they entered. In doing so, it not only destroyed the value of its competitors’ stocks, but also put considerable pressure on its own profit margins.
Levitz’s earnings per share started to decline in 1973, and investors’ perceptions underwent a drastic shift. The market to book ratio of Levitz stock declined from 13.0 to 2.7 within a nine-month period. Levitz’s access to cheap equity capital vanished, along with its special growth opportunity.