As dealmaking is set to continue at historic levels in 2022, CFOs likely need to prepare their companies for action. The ability to rapidly reshape a business portfolio as markets evolve, competitors advance and attractive buy and sell opportunities arise is a huge competitive advantage. But with speed, companies may also need a clear, proactive and disciplined portfolio strategy.
We find that CFOs and other finance leaders who proactively shape their portfolio can help their companies consistently create more value than those who take a more passive and reactive approach. For example, a recent EY analysis of nearly 1,000 companies'-capital allocation strategies shows that those that take a more aggressive and agile approach can generate excess shareholder returns. Agile allocators generated a median total shareholder return (TSR) of 60% from 2012 to 2015 and 49% from 2016 to 2019, compared with a median TSR of passive allocators of 35% and 43%, respectively, for the same time periods.
Yet where some companies excel, many struggle: 60% of finance leaders noted that they need to review their portfolios differently, according to our most recent EY Global Corporate Divestment Study. When it comes to divestitures, more companies than ever — 78% — noted that they continue to retain assets too long.
What are companies getting wrong about the portfolio review process? Here are five of the most common issues encountered and what to do about them.
Addressing common portfolio review pitfalls
1. Avoid distracting metrics
There are really three key performance indicators that drive effective portfolio reviews and help finance leaders quantify each business’s contribution: revenue growth, margin and return on invested capital (ROIC). It can be easy to get distracted with the flavor of the day, but we suggest prioritizing the basics when quantifying portfolio performance.
2. Stop focusing just on the past
Despite the rapid pace of change we've seen these past two years, many companies continue to base portfolio decisions primarily on historical performance. While companies may still need to look at the past to help inform where the business is going, they may also need to project the future trajectory to understand the expected contribution to TSR and long-term value.
3. Temper enthusiasm with realism
Avoid overly optimistic forecasts when deciding which parts of the portfolio to grow, harvest, fix or exit. CFOs can help companies develop realistic assessments of value creation potential — and potential execution risks — by building an objective set of forecasts to evaluate strategic alternatives based on market attractiveness, relative competitive position, strategic fit and financial strength. Leading practices include:
- Calculating value under base and proposed scenarios
- Tracking both capital and cash flow
- Quantifying key performance indicators such as earnings per share, ROIC and TSR
- Measuring the risk associated with each selected option
The graph below is an example of how companies can evaluate potential share price impact of various portfolio options.
4. Beware of unintended consequences
It's important to use scenario modeling to examine interdependencies among the businesses in the portfolio and potential execution risks. For example, a seemingly good divestiture may have such negative impacts on the remaining portfolio that the company can focus on developing a turnaround strategy in lieu of a divestment strategy.
Conversely, before deciding to fix a business, it can be important to determine whether your company has the management capabilities to conduct a successful turnaround. If the experience and capabilities are lacking, you may extract more value by selling. In short, you may want to weigh execution risk against market opportunity when making portfolio decisions.
5. Explain what you didn't do – and why
Remember, proactive portfolio shaping requires timely and effective communication about what you're doing — as well as what you chose not to do and why. A disciplined, objective approach to portfolio management enhances your ability to deliver a compelling and credible message to the street, strengthening the perception among shareholders and analysts that company leaders are basing strategy and actions on sound, financial and market-based principles.
When CFOs identify and navigate the pitfalls in their portfolio review process and focus on market fundamentals, they can move quickly to address changes in the competitive landscape, shifting customer behavior and other strategic imperatives to achieve better results and long-term value creation for the entire enterprise.
Click here to learn more about how we can help you improve your portfolio review strategy and results.
Loren B. Garruto is the EY Americas Transactions and Corporate Finance Leader. Alex Brown is an EY Parthenon Principal, Strategy and Transactions at Ernst & Young LLP.
The views reflected in this article are those of the authors and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.
