Wealth Added Index WAI What It is How It Works

Wealth Added Index (WAI): What It is, How It Works

What Does Wealth Added Index Mean?

Wealth Added Index (WAI) is a metric designed by Stern Value Managament, a consulting firm, that measures value created (or destroyed) for shareholders by a company. According to this calculation method, wealth is created only if the company’s returns, including share price gains and dividends, exceed its cost of equity.

Understanding Wealth Added Index (WAI)

The Wealth Added Index is based on the concept that the cost of equity for a company should be higher than the return on risk-free securities like government bonds because a company is riskier. If a company’s returns do not exceed its cost of equity, shareholders should invest elsewhere. In other words, according to WAI, if the return is less than the cost of equity, the company is destroying shareholder value; if the return exceeds the cost of equity, it is adding wealth for its shareholders.

WAI is similar to Economic Value Added (EVA), another measure by Stern Value Management, in comparing the cost of capital to returns. Traditional accounting return metrics like Return on Equity (ROE) and Return on Assets (ROA) do not consider the cost of capital to achieve those returns over a specific period. A company may have a high ROE, but if the cost of capital to achieve that ROE was even higher, the company destroyed value.

However, there are two key differences between WAI and EVA. Firstly, EVA is backward-looking, calculating only past results. WAI takes into account both past share price performance and prospective performance. Equity value is the present value of all future cash flows, so the current share price reflects the future prospect of value creation. Secondly, EVA is limited in cross-border comparisons due to different accounting standards. WAI, on the other hand, focuses on the movement of share price and dividends, which can be calculated anywhere, overcoming this limitation.