80  The Alchemy of Stock Market Performance margin increased more, J&J still earned a higher margin. Interestingly, both companies earned similar ROIC in 2017, about 22 percent, because Tyson had higher capital productivity. While the impact of increasing expectations (the change in multiple) was similar at the two companies, J&J’s multiple remained at a much higher level. Tyson’s EV/NOPAT multiple increased from 13 times to 17 times, while J&J’s increased from 23 times to 29 times. Tyson had a further seven-percentage-point advantage in TSR due to higher financial leverage. The impact of leverage on J&J’s TSR was actually negative, because it had more cash than debt. In contrast, Tyson’s debt added six percentage points to its TSR. Understanding Expectations As the examples in this chapter have shown, investors’ expectations at the be- ginning and end of the measurement period have a big effect on TSR. A crucial issue for investors and executives to understand, however, is that a company whose TSR has consistently outperformed the market will reach a point where the company will no longer be able to satisfy expectations reflected in its share price. From that point, TSR will be lower than it was in the past, even though the company may still be creating huge amounts of value. Managers need to realize and communicate to their boards and to investors that a small decline in TSR is better for shareholders in the long run at this juncture than a desper- ate attempt to maintain TSR through ill-advised acquisitions or new ventures. This was arguably the point that Home Depot had reached in 1999. Earlier, we used earnings multiples to express expectations, but you can also translate those multiples into the revenue growth rate and ROIC required to satisfy current shareholder expectations by reverse engineering the share price. Such an exercise can also help managers assess their performance plans and spot any gaps between their likely outcome and the market’s expectations. At the end of 1999, Home Depot had a market value of $132 billion, with an earnings multiple of 47. Using a discounted-cash-flow model that assumes constant margins and return on capital, Home Depot would have had to increase rev- enues by 26 percent per year over the next 15 years to maintain its 1999 share price. Home Depot’s actual revenue growth through 2006 averaged a very healthy 13 percent per year, an impressive number for such a large company but far below the growth required to justify its share price in 1999. It’s no surprise, therefore, that Home Depot’s shares underperformed the S&P 500 by 8 percent per year over the period. Since then, Home Depot’s revenues in- creased from $90 billion in 2006 to $108 billion in 2018, an annualized increase of 2 percent per year. A large part of the slow growth was due to the weakness in the housing market, with revenue dropping to $66 billion in 2010 before recovering to the current level. Implications for Managers  81 What should Home Depot’s board of directors have done immediately after 1999, given the company’s high market value? Celebrating is definitely not the answer. Some companies would try to justify their high share prices by considering all sorts of risky strategies. But given Home Depot’s size, the chances of finding enough high-ROIC growth opportunities to justify its 1999 share price were virtually nil. Realistically, there wasn’t much Home Depot could have done except prepare for an inevitable decline in share price: Home Depot’s market value dropped from $130 billion in December 1999 to $80 billion in December 2006 (it increased to over $200 billion by mid-2019). Some companies can take advan- tage of their high share prices to make acquisitions. But that probably wasn’t a good idea for Home Depot because of its high growth—a large-enough man- agement challenge to maintain—even without considering that the retail in- dustry doesn’t have a track record of making large acquisitions successfully. Home Depot’s situation in 1999 was unusual. Most companies, most of the time, will not have much trouble satisfying the shareholder expectations expressed in their current share price simply by performing as well as the rest of their industry. We have reverse engineered hundreds of companies’ share prices over the years using discounted cash flows. With the exception of the Internet bubble era (1999–2000), at least 80 percent of the companies have had performance expectations built into their share prices that are in line with in- dustry growth expectations and returns on capital. TSR for a company among these 80 percent is unlikely to be much different from the industry average unless the company performs significantly better or worse than expected, relative to its industry peers. The other 20 percent, however, should brace themselves for a significantly faster or slower ride on the treadmill. Managers who reverse engineer their share prices to understand expectations of their ROIC and growth can benefit from seeing on which side of this 80/20 divide they fall. Implications for Managers The expectations treadmill makes it difficult to use TSR as a performance mea- surement tool. As we saw in the example of Tyson and J&J Snack Foods, the sizable differences in TSR for the two companies from 2013 to 2017 masked the big difference in expectations at the beginning of the measurement period. In Home Depot’s case, living up to the expectations was virtually impossible, as no company can run that fast for very long. As a result of the expectations treadmill, many executive compensation systems tied to TSR do not reward managers for their performance as manag- ers, since the majority of a company’s short-term TSR is driven by movements in its industry and the broader market. That was the case for the many execu- tives who became wealthy from stock options in the 1980s and 1990s, a time