We are going to introduce this year's list of Wealth Creators with a prediction: That it is going to make a lot of companies-mainly those in FMCG-unhappy. And understandably so. When we last put out the list of India's Biggest Wealth Creators in April 2003, Hindustan Lever Ltd (HLL) was the topper. ITC came in at No. 5, and Nestle at No. 9. This year, they don't even make it to the top 100. That's not because Mr Banga, or Mr Deveshwar, or Mr Donati have done something disastrous in the course of just one year. Rather, the change is due to the wholescale change that BT and Stern Stewart have effected in calculation of wealth creation. Our previous listing was based on market value added (MVA), which is market value of a firm minus its economic capital (see The Methodology on page 98 in the April 13, 2003, issue of Business Today). But this year's rankings are based on what Stern Stewart calls Wealth Added. So just what is Wealth Added?

Put simply, Wealth Added measures the total wealth flow over a given period of time (we chose five years, from the end of 1998 to the end of 2003 and the term encompasses increase in market value of equity, dividends and share buybacks, net of new equity issuances) in excess of investor's expected return (on the market value of a company's equity). To put it as an equation, Wealth Added = Change in Market Capitalisation - Required return + Dividends - New Equity Issues.

In this equation Change in Market Capitalisation is the market capitalisation at the end of the period less that at the beginning of the period.

And Required Return is market capitalisation at the beginning of the period multiplied by the cost of equity. We have taken cost of equity because it is a convenient (and mostly reliable) proxy for expected return. We have explained this calculation for Infosys Technologies on page 66 (See How We Did It).

The robustness of the wealth added metric stems from its ability to factor in required return. Let's explain this. When the share price of a company dips, the wealth flow becomes negative, irrespective of the company's ability to return profits and pay dividends. This is because the company has created expectations (or the market has built expectations of the company) that cannot realistically be met. Ergo, the stock falls, and the wealth added becomes negative.

Take the FMCG business. Once stockmarket darlings, most companies in the sector have fallen out of favour now, even though they continue to deliver sound operating results year-on-year. What happened? The better the management continued to perform, the more the market expected from them. The expectations were simply moving too fast, and eventually these companies-the prime examples being HLL and ITC-just could not keep up with the required pace.

Pharma and IT have emerged as the new stockmarket darlings. These companies have exceeded investor expectations over the last five years, but to remain extraordinary performers over the next three-to-five years, they will need to continue to exceed expectations as reflected in their stock prices. Similarly, companies in the core sector (think ONGC, Tata Steel or BSES) have made surprising gains. Why? They exceeded the wealth flow expectations of investors by sticking to the basics-improving operating margins through cost management and pricing, enhancing asset productivity and working capital management.

All the gainers, however, will have to work hard to live up to, or even exceed, investor expectations. In effect, they will have to run faster to stay at the same place. The Wealth Added Index, then, reflects what investors expect of their companies and how much the management is actually delivering. For shareholder-value driven companies, there cannot be a better wake-up call.