Lecture notes S2 L 8 - 1 Earnings persistence Main...

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1 1 Earnings persistence Main References Subramanyam and Wild, Ch. 11 Palepu & Healy, 2 Key Concepts and objectives • The key objectives in credit and equity analysis are as follows: – Understand earnings persistence, its determinants, and relevance in equity valuation – Understand the process of adjusting and recasting earnings for business decisions
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2 3 Earnings Persistence • Analyzing earnings persistence is key to effective credit, equity analysis and valuation • Attributes of earnings persistence include: – Stability – Predictability – Variability – Trend 4 Earnings Persistence • Two common methods used to assess earnings persistence are: – Recasting income statement – Adjusting income statement • Recasting and adjusting earnings help to determine earning power.
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3 5 Earnings Persisten ce • Information for Recasting and Adjusting – Income statement and its subdivisions: • Income from continuing operations • Income from discontinued operations • Extraordinary gains and losses • Cumulative effect of changes in accounting principles – Notes to the financial statements – Management’s Discussion and Analysis – Any others relevant information such as product-mix changes, technological innovations, work stoppages, and raw material constraints 6 Earnings Persistence Objectives of recasting: • Rearrange earnings components to provide a meaningful classification and relevant format for analysis. – Components can be rearranged, subdivided, or tax effected, but the total must reconcile to net income of each period. – Discretionary expenses should be segregated – Distinct components like income (loss) of unconsolidated subsidiaries should be segregated. – Components reported pretax must be removed along with their tax effects if reclassified
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4 7 Earnings Persistence Objectives of adjusting: • Adjusting aims to assign earnings components to the periods in which they best belong. • Uses data from recast income
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This note was uploaded on 08/27/2011 for the course CORPFIN 7827 taught by Professor Prokim during the Three '11 term at University of Adelaide.

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Lecture notes S2 L 8 - 1 Earnings persistence Main...

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