What is true earnings?
If you look at a financial results, sometimes you can see different earnings being reported. We can also derive our interpretation of earnings based on cash flow or other parameters. What do all these earnings mean and which is the true earnings for the year?
As earnings and earnings growth are important components in the DCF calculation, it is important to ensure we consider this carefully. I will start by defining all the earnings and I will use Haw Par FY2017 financial results as a case study.
A) GAAP earnings - this is the straight forward and I think most people will use this. The reported net income or profit taken directly from the income statement. For Haw Par, it is $125.5m or $0.57/share.
B) Comprehensive income - this includes other non-operation items, eg currency translation difference, fair value changes of financial assets etc. This is also reported in the income statement. For Haw Par it is $793.6m or $3.60/share.
C) Free cash flow - this is simply calculated as Cash Flows from from operating activities less Capital Expenditures (Purchases of property, plant and equipment). It is $106.8m - $8m = $98.8m or $0.45/share
D) Owner earnings - Buffett defined this as Reported earnings + Depreciation and Amortisation + changes in working capital - Capital expenditure. It will be $125.5m + $3.5m + (-$5.8m + $1.6m+ $4.6m) - $8m = $121.4m or $0.55/share
E) Look through earnings - the concept is that all corporate profits benefit shareholders regardless they are paid out as dividends or as retained earnings. In brief, this is the company own reported GAAP earnings plus the share of undistributed earnings of the financial assets, which are not reported in the company P&L under the conventional accounting. For Haw Par, the undistributed retained earnings from UOB & UOL comes up to $153m. If I add this to the pre-tax profit of $140.8m and apply the same tax rate of 10.9%, I will get look through earnings of $261.8m or $1.20/share
F) Underlying earnings - this will be the earnings generated from the core business. It excludes one-off charges, any extraordinary event or highly irregular financial transactions which might false inflate the earnings, eg profit from sales of a subsidiary business. For Haw Par, there seems to be no one-off charges, so in this case, the underlying and GAAP earnings are the same.
G) There could be combinations of the above, eg using underlying earnings instead of GAAP earnings in calculating the Owner earnings or FCF or Look Through earnings.
There could be some errors in my calculation above, so don’t take it as absolute. The intent is not to accurately calculate all the earnings but to show the different earnings we can get.
Can see that it ranges, on per share basis, from $0.45 to $3.60 for Haw Par case. This is a quite a huge different and will surely affect the intrinsic value calculation and also the ratio like PE, ROE, ROA, ROIC.
Like to hear from value investors on what is your approach in determine the true earnings of a company. I have my approach, which I can share later.