36  Fundamental Principles of Value Creation all Standard & Poor’s (S&P) 500 companies, excluding financial institutions. Yet at the end of 2018, the median P/E of consumer packaged-goods compa- nies was about 15, almost exactly the same as the median S&P 500 company. The valuations of companies in this sector rested on their high ROICs—in aggregate above 40 percent, compared with an aggregate ROIC of 22 percent for the S&P 500 in 2018. To test whether the core valuation principle also applies at the level of countries and the aggregate economy, we compared large companies based in Europe and the United States. The median trailing P/E ratio for large U.S. companies was 15.5 times, versus 12.8 for large European companies. The difference in valuation relative to invested capital is even more extreme. The median enterprise value to invested capital for U.S. companies was 5.4, ver- sus 3.2 for European companies. Some executives assume the reason is that investors are simply willing to pay higher prices for shares of U.S. compa- nies (an assumption that has prompted some non-U.S. companies to consider moving their share listings to the New York Stock Exchange in an attempt to increase their value). But the real reason U.S. companies trade at higher multiples is that they typically earn higher returns on invested capital. The median large U.S. company earned a 30 percent ROIC (before goodwill and intangibles) in 2018, while the median large European company earned 19 percent. A large part of the difference is a different industry mix; the United States has many more high-ROIC pharmaceutical, medical-device, and tech- nology companies. These broad comparisons also hide the fact that some European companies—for example, Robert Bosch in auto parts and Reck- itt Benckiser in consumer packaged goods—outperform many of their U.S. counterparts. More evidence showing that ROIC and growth drive value appears in Chapter 7. Implications for Managers We’ll dive deeper into the managerial dimensions of ROIC and growth in Chapters 8 and 9, respectively. For now, we outline several lessons managers should learn for strategic decision making. Start by referring back to Exhibit 3.6, because it contains the most im- portant strategic insights for managers concerning the relative impact that changes in ROIC and growth can have on a company’s value. In general, companies already earning a high ROIC can generate more additional value by increasing their rate of growth, rather than their ROIC. For their part, low- ROIC companies will generate relatively more value by focusing on increas- ing their ROIC. For example, Exhibit 3.7 shows that a typical high-ROIC company, such as a branded consumer packaged–goods company, can increase its value by Implications for Managers  37 10 percent if it increases its growth rate by one percentage point, while a typical moderate-ROIC company, such as the average retailer, will increase its value by only 5 percent for the same increase in growth. In contrast, the moderate-ROIC company gets a 15 percent bump in value from increasing its return on invested capital by one percentage point, while the high-ROIC company gets only a 6 percent bump from the same increase in return on invested capital. The general lesson is that high-ROIC companies should focus on growth, while low-ROIC companies should focus on improving returns before grow- ing. Of course, this analysis assumes that achieving a one-percentage-point increase in growth is as easy as achieving a one-percentage-point increase in ROIC, everything else being constant. In reality, achieving either type of in- crease poses different degrees of difficulty for different companies in different industries, and the impact of a change in growth and ROIC will also vary between companies. However, every company needs to conduct the analysis to set its strategic priorities. Until now, we have assumed that all growth earns the same ROIC and therefore generates the same value, but this is clearly unrealistic: different types of growth earn different returns on capital, so not all growth is equally value-creating. Each company must understand the pecking order of growth- related value creation that applies to its industry and company type. Exhibit 3.8 shows the value created from different types of growth for a typical consumer products company.5 These results are based on cases with which we are familiar, not on a comprehensive analysis. Still, we believe they reflect the broader reality.6 The results are expressed in terms of value created for $1.00 of incremental revenue. For example, $1.00 of additional revenue from a new product creates $1.75 to $2.00 of value. The most important impli- cation of this chart is the rank order. New products typically create more value for shareholders, while acquisitions typically create the least. The key to the difference between these extremes is differences in returns on capital for the different types of growth. EXHIBIT 3.7  Increasing Value: Impact of Higher Growth and ROIC Change in value, % 1 percentage point higher growth 1 percentage point higher ROIC High-ROIC company Moderate-ROIC company Typical packaged-goods company Typical retailer 10% 15% 6% 5% 5 This exhibit will look different for different industries. 6 We identified examples for each type of growth and estimated their impact on value creation. For instance, we obtained several examples of the margins and capital requirements for new products.