Differences in adjustments to the share count related to special dividends and demergers can impair the comparability of earnings per share. Under IFRS, EPS growth depends on whether a stock consolidation accompanies a distribution. However, stock consolidations, by themselves, have no economic impact and should not affect performance metrics.
In Vivendi’s recent distribution of shares in Universal Media Group, the lack of an accompanying stock consolidation resulted in a discontinuity in per share metrics. However, in a similar distribution by GSK, a stock consolidation produced a very different outcome. We explain the problem for investors and how you can adjust to ensure comparability.
APMs
Do not use non-GAAP metrics in equity valuation
A forecast of profit is used for both valuation multiples and as a starting point in deriving free cash flow for DCF valuations. But should you use a forecast of the reported IFRS or GAAP measure, or a forecast of the adjusted non-IFRS or non-GAAP alternative performance measure (APM) presented by management?
We think equity valuations should be based on forecasts of reported IFRS or GAAP earnings (albeit with some adjustment related to intangible assets). Forecasts of management APMs can be useful for understanding trends in performance but using these in equity valuation is likely to introduce a structural bias.
Continue reading “Do not use non-GAAP metrics in equity valuation”Non-GAAP is more than earnings before bad stuff
Non-GAAP measures can be useful for investors, but they are also controversial. Some argue that certain non-GAAP adjustments are unacceptable and should not be permitted. This recently happened to US company MicroStrategy, where the SEC required it to amend the presentation of cryptocurrency gains and losses.
We do not agree with the SEC approach and believe MicroStrategy gives valid reasons for its cryptocurrency non-GAAP adjustment. We have less sympathy with other aspects of the company’s non-GAAP earnings calculation. However, we believe that the disaggregation that results from all non-GAAP disclosures generally benefits investors.
Continue reading “Non-GAAP is more than earnings before bad stuff”Disaggregation is key to understanding performance
Limited disaggregation of income and expense items with different characteristics impairs investors’ ability to assess and forecast performance. Recent proposals by the IASB for a new disaggregation principle and related disclosures of ‘unusual’ items will help. However, in our view, they do not go far enough.
The IASB also proposes to include management alternative performance measures (non-GAAP or non-IFRS) within audited financial statements. We welcome this. Additional subtotals can be helpful if they are clearly described and what is omitted is clearly identified. What would also help is to ban the use of labels such as ‘underlying’, ‘core’ and ‘recurring’.
Continue reading “Disaggregation is key to understanding performance”Forecasting ‘sticky’ stock-based compensation
Stock-based compensation grants to employees in 2020 are likely to be affected by the changes to share prices and reduction in profitability currently being experienced by many companies. However, the impact on the related expense and on reported profit may not be what you might expect.
For most companies, stock-based compensation is a ‘sticky’ expense that is only indirectly or partially affected by current period changes. Limited disclosure in financial statements makes forecasting this expense a challenge. You should focus on the value of new grants, the vesting period and the effect of potential changes to assumptions. Our interactive model will help.
Continue reading “Forecasting ‘sticky’ stock-based compensation”Don’t rely on APMs, disaggregate IFRS
Alternative performance measures (APMs) can be helpful for investors, but not necessarily the figure itself. It is the disaggregation of performance that is the real benefit. Focusing solely on adjusted measures means you will miss important aspects of profitability.
We explain how you can use APMs to better understand performance, but without missing key elements. In our view this approach would provide a better basis for investor forecasts, as we demonstrate by disaggregating the IFRS earnings of GlaxoSmithKline.
Continue reading “Don’t rely on APMs, disaggregate IFRS”Should you ignore intangible amortisation? – AstraZeneca
Like many companies, AstraZeneca excludes intangible asset amortisation from its adjusted performance metrics. The stock currently trades at a price earnings ratio of 23x based on ‘core’ 2018 earnings, but without the add back the PE would be about 37x. Is the add back justified? And if so do companies add back the right amount?
The intangible amortisation problem in equity analysis arises from the inconsistency between the accounting for purchased and self-developed intangible assets. We argue that the accounting treatment of subsequent expenditure, either capitalised or expensed, determines the appropriate adjustment to reported earnings.
Continue reading “Should you ignore intangible amortisation? – AstraZeneca”Dot-com bubble accounting still going strong – Tesla
Some 20 years ago the dot-com bubble was in full swing. A feature of many technology companies at the time, and arguably a factor contributing to the bubble, was not expensing the significant amounts of stock options granted to employees.
Today stock-based compensation is included in IFRS and GAAP profit measures. However, many companies still exclude this item from key performance metrics provided to investors. Surely it is time for this practice to stop? We use the alternative performance measures given by Tesla to illustrate.