Earnings Measures

Understanding Sustainable Earnings Sustainable earnings are also called permanent earnings and non- sustainable earnings are called transitory earnings.

Market Capitalization Company’s fair market value Market price per share × Number of shares outstanding (for public companies) Reflects the capital market’s outlook regarding the company’s future performance And, hopefully, reflects the true intrinsic value of a company – As a going concern – The value the company can be sold for in an efficient market 3

Earnings Sustainable (permanent) earnings – The level of earnings expected to persist. Transitory earnings – Earnings that are non-sustainable – Include single-period, non-recurring amounts Extraordinary gains/losses Restructuring charges Changes in accounting principle Discontinued operations 4

Persistence on the Income Statement 5 Greater Persistence Less Persistence Amounts more central to a company’s core operations are reported first. Revenues$424,000 Cost of goods sold238,000 Gross profit186,000 Operating expenses95,000 Operating income91,000 Interest income1,500 Interest expense-3,400 Income before income taxes89,100 Income taxes expense28,500 Income from continuing operations60,600 Discontinued Operations: Operating loss from discontinued operations, net of taxes of $ Gain on discontinued operations, net of taxes of $1,6505,220 Income before extraordinary loss and cumulative effect of a change in accounting prin.64,900 Extraordinary gain(loss) from hurricane, net of tax-1,100 Income before cumulative effect of accounting principle change, net of tax63,800 Cumulative effect of a change in accounting principle, net of tax3,200 Net income$67,000

Special Income Statement Items Typically include – Gains and losses from the sale of long-lived assets – Litigation settlements – Impairment charges for long-lived assets – Restructuring charges – Change in accounting principle – Extraordinary gains and losses – Discontinued operations 6

Extraordinary Gains and Losses Gains and losses that are both – Unusual, and – Infrequent Reported as a one-time effect, net of taxes Examples – Natural disasters in areas where the cause is not usual and infrequent – Asset appropriations by foreign governments 7

Earnings Per Share (EPS) Represents the profit earned by a company per share of common stock held by shareholders Public companies must report – Basic EPS = Net income ÷ Number of common shares outstanding – Diluted EPS = 8 Net income ÷ Number of common shares outstanding adjusted for diluted claims

Investigate Pick a public company Find their most recent annual report Answer these questions – What were their net income, basic EPS, and diluted EPS? – Did they have any special items? What were they? Look up their current stock price and number of shares outstanding. – Compute their market capitalization – Compare stock price to earnings per share? What does that tell you?