|
Income Statement Analysis
- Great companies and good
EPS growth
do not guarantee
stock market profits
- The P/E ratio can create
buying opportunities
- Mishaps can create steals
- Unusual charges reduce the
value of your stock
- ROE is the single best tool
for investors
- ROA is another valuable tool
- Investors pay for high profit
margins
- Lenders can eat up all the
profits
- Depreciation creates
deferred taxes, which have
equity-like qualities
- EPS is a complicated
calculation
|
|
Unusual charges reduce the value of
your stock
Investors need to concentrate on the non-recurring,
extraordinary, or unusual items in the P&L, as well as those “non-owner”
items charged directly to shareholders’ equity. Any charges that reduce
shareholders’ equity ultimately reduce the value of one’s investment. Cash
flow that would have been available to the shareholders is being, or has
been, diverted to cover such charges. These items include asset impairment
charges, losses on the disposal of discontinued operations,
other-than-temporary write-down of investments, legal settlements, etc. In
our current business climate, these “unusual” charges are everyday business
events, and should therefore be viewed as such.
Unusual charges represent the quality of decisions
made by management and they do affect the value of the company. If there is
less money in the kitty, then the value of your holdings is less.
Additionally, “back door” expenses need to be
factored into investment decisions. These are non-owner charges that are
paid out of shareholders’ equity and bypass the income statement. By
definition, shareholders’ equity is equity that belongs to the shareholders.
Comprehensive income charges, however, are non-owner items that are charged
directly to shareholders’ equity. The back door has been pushed open and
money is escaping. Non-owners now have their hands in the pockets of
shareholders.
The net income of a company belongs to the owners; no
other stakeholder should have a claim to these funds. Giving employees stock
options or stock grants for “sweat equity” is one issue; allowing direct
non-owner charges to equity is just wrong and should not be allowed, but it
is! Essentially, the net income and cash flow that belongs to the present
shareholders is being given to non-owners. That said, you as an investor
must decide where that leaves you.
In summary,
businesses are not solely valued on earnings/cash flow from recurring
operations. Unusual non-operating expenses drain financial resources which,
ultimately, negatively affect share prices.
|
|
