Almost 4 years ago when I was new to investing, I was unable to differentiate the underlying earning power of the various companies. I recalled that I took action immediately on a company when I saw its earnings per share spiked up – thinking that it was undervalued. However, I did not conduct my due diligence to verify what was the source of the strong earnings growth. I was left wondering why did the share price not move.
Later… a friend of mine guided me and showed that it was because of its one-off sale of its assets and it did not represent the underlying earning of the business! In fact, its underlying earnings deteriorated!
In this article, we will share with you what are one-offs and how you can normalised the earnings of a company.
In our day-to-day analysis of companies, it is important to understand whether a company’s net profit attributable to owners of the company is a figure that is representative of the underlying earnings power of the company. There is a tendency where the net profits could be overstated or understated because of one-off(s) or exceptional items. I personally regard one-off items as neutral, it does not mean that the company is a good or bad company. As an investor, you must know the source of such one-off(s) and understand how it affects the net profit (bottom line) of the company’s earnings.
What are one-off(s) or exceptional items?
They are items that arise out of a company’s ordinary and day-to-day operations. The nature of such items is infrequent and non-recurring. Hence, these figures need to be adjusted with the net profits.
There could be many reasons for such items to happen such as:
- Legal settlements
- Insurance settlements
- Asset write-down
- Fair value gains
- Gain (Loss) on sale of assets / investments
- Merger & Related Restructuring Charges
- Currency exchange gains
- If it is a one-time loss, the figure should be added to the net profit because we do not expect the company to lose this amount gain.
- If it is a one-time gain, the figure should be deducted from the net profit because we do not expect the company to gain this amount again.
Example #1 – Capilano Honey
In September 2012, Capilano reported a fire destroyed 80% of their hotroom and decanting facilities.
For FY2013, Capilano reported a one-time gain of $772,302 which consisted of the insurance proceeds and damage to assets and consequential expenses.
Damage to assets
It also incurred other one-time expenses such as:
|Net foreign exchange loss||($162,748)|
|Loss on disposal of property, plant and equipment||($25,974)|
In totality, it made a one-time net gain of $577,330. The figure is obtained by deducting $194,972 from $772,302.
For that, we have to adjust to derive the underlying profit for the business by deducting $577,330 from their net profit of $3,446,604. This gives the figure of A$2.9 million which is a more accurate representation of Capilano’s earnings.
Example #2 – SATS
In SATS’s 1Q FY2016/17 results, the Group recorded a gain on disposal of $9.3m from the sale of their Senoko property. It was sold to Neo Group. The Group also recorded a loss of $0.7m due to divestment and shareholding dilutions of their associates.
|Gain on disposals||$9.4m|
It also made some one-time losses / adjustments such as:
|Foreign exchange loss, net||($0.9m)|
|Write-off for stock obsolescence||($0.1m)|
|Under-provision of taxation||($0.3m)|
In totality, it made a one-time net gain of $7.4m. The figure is obtained by deducting $1.3m from $8.7m.
It reported a net profit of $64.1m whereas the underlying net profit is $56.7m. The $56.8 million is derived from deducting $7.4m from $64.1m.
As a cautious note, be careful if a particular company has big amounts of one-off(s). You might want to question the nature of its business. After all, earnings is just one equation of performing a company analysis. Research work is still needed on other aspects of the company.
The question is, ‘how can I learn more?’. We would like to invite you to our Value Growth Workshop where we will guide you in simple steps on how you can avoid losses made by many and make massive profits. To find out more, click watch our video on Value Investing!
(source: SGX announcements, ASX announcements, SATS, Capilano Honey)
Disclaimer: All facts and opinions presented are for educational purposes only. This is not a recommendation to buy or to sell. The author(s) involved in the writing of this piece does not have any current vested interest of the companies mentioned. If you require expert financial or other assistance or legal advice, a competent professional should be consulted.