This report summarizes our series of reports on how to protect your portfolio from blow-ups. We detail all the red flags and hidden items buried in SEC disclosures that we fix to derive economic earnings.
Reported earnings don’t tell the whole story of a company’s profits. They are based on accounting rules originally designed for debt investors, not equity investors, and are often manipulated by companies to manage earnings. As a former accountant and current member of FASB’s Investor Advisory Committee, I know first hand that accounting regulators recognize these challenges - details here. In the meantime, investors need to do their own diligence.
Converting GAAP data into economic earnings should be part of every investor’s diligence process. The challenge is that diligence is very difficult and time consuming. We provide this diligence with 100% transparency and deliver via an easy-to-use website. Take a free trial or our research. Or get a free demo from one of our experts.
Each of the following reports explains each adjustment we make across the 3,000+ companies we cover.
A) Income Statement Adjustments to derive NOPAT: to convert reported GAAP income to net operating profit after tax (NOPAT):
- Remove asset write-downs hidden in operating expenses
- Remove non-operating expenses hidden in operating earnings. This includes foreign currency exchange losses hidden in operating earnings.
- Remove non-operating income hidden in operating earnings
- Add back change in reserves
- Remove income and loss from discontinued operations (except for REITs)
- Add back implied interest for the present value of operating leases
- Adjust for non-operating tax expenses
- Historical adjustments: Add back goodwill amortization prior to 2002 and include employee stock option expense prior to 2006
- Remove reported non-operating items
B) Balance Sheet Adjustments To Derive Invested Capital: to convert reported assets to invested capital:
- Add back off-balance sheet reserves
- Add back off-balance sheet debt due to operating leases
- Remove discontinued operations
- Remove accumulated Other Comprehensive Income
- Add back asset write-downs
- Remove deferred compensation assets and liabilities
- Remove deferred tax assets and liabilities
- Remove over-funded pensions
- Remove excess cash
- Prior to 2002: Add back unrecorded and accumulated goodwill
- Adjust for midyear acquisitions
- Remove non-operating unconsolidated subsidiaries
C) Valuation Adjustments for our Discounted Cash Flow Model, Economic Book Value, and Enterprise Value calculations:
- Employee stock option liabilities
- Preferred stock
- Minority interests
- Adjusted total debt (including off-balance sheet debt)
- Pension net funded status
- Net deferred tax assets or liabilities
- Net deferred compensation assets or liabilities
- Discontinued operations
- Excess cash
- Unconsolidated Subsidiaries
We’ve performed unrivaled due diligence on over 70,000 annual reports over the past decade. This diligence enables us to provide unrivaled earnings quality and valuation research.
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