When facing the challenge of improving total shareholder return (TSR), most executives default to growth. But as much as investors value growth, they want to see that companies can manage capital efficiently.
Different paths to TSR
To get a deeper understanding of the relationship among growth, capital investment and TSR, EY professionals recently analyzed value creation for companies in the S&P 500 using a proprietary forecasted cash flow model.
Our findings challenge conventional wisdom, revealing sharply different paths to positive TSR depending on a company’s return on invested capital (ROIC).
For the study, we divided the sample companies into high- and low-ROIC groups, based on average historical ROIC over a three-year period, 2021-2024, and then examined how each group fared with TSR. (The analysis included 360 companies from the S&P 500 but excluded the financial services sector, companies that entered or exited the S&P 500 during the observation period, and some companies in sectors still severely affected by COVID-19 disruption at the beginning of the period, such as cruise operators, airlines and casinos.)
Tortoise vs. hare, grasshopper vs. ant
The lessons of the analysis mirror the morals of two fables: “The Tortoise and the Hare” and “The Grasshopper and the Ant.”
For companies with low ROIC — tortoises and hares, racing toward a common goal — the priority should be on earning the right to grow by improving their ability to get the most value from their investments. Meanwhile, companies with high ROIC — grasshoppers and ants, each taking opposite strategies — should prioritize deploying new capital at attractive returns.
The survey results have profound lessons for companies in each quadrant of high or low ROIC or TSR.
Companies with low ROIC: tortoises and hares
• Like the tortoise that wins the race through steady determination, companies with low ROIC succeeded by improving investment efficiency and focusing on steady, disciplined growth.
• By contrast, the hare represents overconfidence: companies with low ROIC that continued to chase growth without addressing their underlying inefficiencies.
• Over time, the tortoises outpaced the hares by focusing on strategic improvements.
Companies with high ROIC: ants and grasshoppers
• Like the ant, companies with high ROIC are disciplined, organized planners. They methodically grew profit margins through careful investments in high-return opportunities, making the most of their high-ROIC strength to drive sustainable growth in TSR.
• And like the carefree grasshopper, other companies that started with a high ROIC overinvested resources in low-return assets, destroying shareholder value and diminishing TSR.
• The grasshoppers’ wasteful approach contrasts sharply with the ants’ focused strategy.
Tortoises: repositioning for growth
The survey’s tortoise companies succeeded by treating low ROIC as a high-priority concern. They limited capital deployment (15-point TSR impact) and improved ROIC by 44% through a combination of better capital efficiency and increased profit margins to create a 59% net contribution to TSR.
Hares: going nowhere fast
Hare companies, by contrast, doubled down on growth by deploying significantly more capital in underperforming businesses (56%, compared with 15% for tortoises), despite having low ROIC. The continuing weak ROIC offset the value of the investments (-26% impact).
The net effect of these factors was that TSR grew only half as much as that of their slow-but-steady peers (30% vs. 59% impact). Investors’ concern about the approach led to an additional -39% TSR impact as expectations fell, resulting in a total net impact of -9% TSR. The lesson is that executives cannot grow their way out of their low-return problem without first demonstrating capital discipline.
Ants: investing thoughtfully
And what about the ROIC leaders? What should they do to maintain results?
Companies that are fortunate to have high ROIC should invest for growth — but they must do so in a disciplined way so they do not dilute their strong ROIC. The data shows that companies in this category vary widely in their ability to do this.
Both high- and low-TSR performers — the ants and grasshoppers, respectively — deployed more capital and grew sales. The ants did so by investing while maintaining or enhancing capital efficiency and margins, earning greater investor confidence and growing TSR by 73%.
Grasshoppers: squandering advantages
The results for the low-TSR segment, the grasshoppers, show that getting it wrong is expensive. These companies deployed capital at high levels (84-point vs. 61-point contribution to TSR), but their declining ROIC negated the benefits by -74 points. Investors again lowered their expectations (-20-point impact), resulting in a mere 10% TSR gain, compared with 73% for the better-performing ants. The grasshopper companies wasted their high historical ROIC by investing inefficiently and lost the confidence of their investors.
Becoming ants and tortoises
To find their paths to positive TSR, companies need to take two steps:
Understand ROIC
Leaders must determine whether they have earned the right to grow by evaluating how effectively they are using their balance sheet, with the key benchmark being whether ROIC exceeds the cost of capital. Depending on where they land, companies using this measure can choose one of two paths to success.
Choose your path to success
Those companies with low ROIC should emulate the tortoises, focusing on improving capital efficiency and margins, such as by restructuring underperforming units, divesting noncore assets, or making operational improvements. When ROIC exceeds the cost of capital, they have earned the right to invest for growth.
Companies that already have a healthy balance sheet and high ROIC have more options than others. But they must be systematic, like the ant in the fable, by making smart investment decisions that build future value and avoid squandering their advantage.
Read the complete EY research report Earning the Right to Grow and learn more about how EY teams are helping companies reimagine their enterprises and growth strategies through a deeper understanding of value creation.
Mitch Berlin is a partner and EY Americas vice chair, Strategy and Transactions, at Ernst & Young LLP.
Whitt Butler is a partner and EY Americas vice chair, Consulting, at Ernst & Young LLP.
The views reflected in this article are the views of the authors and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.