Chapter11 - Equity Analysis and Valuation CHAPTER 11...

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Equity Analysis and Valuation 11 CHAPTER
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Earnings Persistence Recasting and Adjusting • Earnings persistence is a key to effective equity analysis and valuation • Analyzing earnings persistence is a main analysis objective • Attributes of earnings persistence include: Stability Predictability Variability Trend Earnings management Accounting methods Analyze
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Earnings Persistence Recasting and Adjusting Two common methods to help assess earnings persistence: Recasting of income statement Adjusting of income statement
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Earnings Persistence Recasting and Adjusting Information for Recasting and Adjusting Income statement, including its subdivisions: Income from continuing operations Income from discontinued operations Extraordinary gains and losses Cumulative effect of changes in accounting principles Other financial statements and notes Management commentary in financial statements Management’s Discussion and Analysis Other: product‑mix changes, technological innovations, work stoppages, and raw material constraints
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Earnings Persistence Recasting and Adjusting Objectives of Recasting 1. Recast earnings and earnings components so that stable, normal and continuing elements comprising earnings are distinguished and separately analyzed from random, erratic, unusual and nonrecurring elements 2. Recast elements included in current earnings that should more properly be included in the operating results of one or more prior periods Recasting and adjusting earnings also aids in determining earning power
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General Recasting Procedures Income statements of several years (typically at least five) are recast Recast earnings components to yield meaningful classifications and a relevant format for analysis Components can be rearranged, subdivided, and tax effected Total recasted components must reconcile to reported net income Earnings Persistence Recasting and Adjusting
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Specific Recasting Procedures • Discretionary expenses are segregated • Distinct components are segregated (such as equity in income of unconsolidated subsidiaries) and often reported net of tax • When components of continuing income are separately reclassified, their pre-tax amounts along with their tax effects must be removed • Income tax disclosures enable one to separate factors that either reduce or increase taxes such as: Deductions—tax credits, capital gains rates, tax-free income, lower foreign tax rates Additions—additional foreign taxes, non-tax-deductible expenses, and state and local taxes (net of federal tax benefit) Earnings Persistence Recasting and Adjusting
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Recasting and Adjusting -- Illustration Earning Persistence Campbell Soup Company Recast Income Statements ($ mil.) Item Year 11 Year 10 Year 9 Year 8 Year 7 Year 6 13 Net sales $ 6,204.1 $ 6,205.8 $ 5,672.1 $ 4,868.9 $ 4,490.4 $ 4,286.8 19 Interest income 26.0 17.6 38.3 33.2 29.5 27.4 Total revenue $ 6,230.1 $ 6,223.4 $ 5,710.4 $ 4,902.1 $ 4,519.9 $ 4,314.2
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Chapter11 - Equity Analysis and Valuation CHAPTER 11...

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