Failed acquisitions do not always result in goodwill impairments. Management optimism is part of the problem, but so is application of the impairment test in a way that maximises the shielding effect of other assets. This reduces the value of goodwill impairments for investors. Analysing the success or failure of M&A is important to assess management stewardship. We applaud the IASB’s proposal for more disclosure, but also believe the goodwill impairment test needs a critical review. Some u...| The Footnotes Analyst
Use this model to derive ‘target’ enterprise value multiples that are consistent with specified value drivers, including measures of growth, return on investment, margins and capital intensity. The model is based on an underlying 2-stage DCF methodology. We explain its derivation, the key assumptions and how to select appropriate value driver inputs.| The Footnotes Analyst
Last year we published an article about the calculation of free cash flow and the alternative approaches used by Amazon. That original article is still very relevant; recent accounting changes have prompted us to publish an update. New accounting rules effective in 2019 change and improve the data available to you under both IFRS and US GAAP when making the adjustments we advocate. We explain these changes, provide updated free cash flow measures for Amazon, based upon their 2019 financial st...| The Footnotes Analyst
Are you trying to identify what is ‘priced in’ to the current stock price or to work out a terminal value in a DCF analysis? A target valuation multiple calculation may be the answer. We present a simple interactive model. Many dismiss valuation multiples as being too simplistic; however, multiples are just DCF in disguise. We demonstrate that you can derive a price earnings ratio with the same value drivers as you would use in a discounted equity cash flow model.| The Footnotes Analyst
Pension accounting can produce some odd results, such as companies that report a pension surplus, but which still make ‘deficit reduction’ cash contributions. This illustrates an underlying problem in financial reporting where pension assets and liabilities may not reflect the true economic position of the sponsoring company. We think the increasing closure of defined benefit schemes to new accrual, and the growing trend to de-risk, including the use of pension buy-ins and buy-outs, makes...| The Footnotes Analyst
Explore economic and accounting volatility in insurance under ifrs 17, focusing on cash flow estimates and market changes affecting liabilities.| The Footnotes Analyst
Enterprise value multiples allow for better comparisons where capital structure differs and they provide a clearer focus on the core business. EV multiples also more reliably capture the cost of debt finance and other non-common stock claims; the amount reflected in net income and earnings per share can be out of date and incomplete. Although they are generally our preferred approach, EV multiples present computational challenges that are not present in equity multiples. All valuation multipl...| The Footnotes Analyst
Stock-based compensation can be difficult. Two approaches to measurement, valuation uncertainty, frequent adjustments for changes in estimates (including sometimes the stock price), and a dilutive effect in addition to an expense, all contribute this being a topic many investors try their best to avoid. Investors are not helped by inadequate stock-based compensation disclosures. Some companies go further than required by accounting standards, such as Swiss bank UBS, whose helpful additional a...| The Footnotes Analyst
Acquisitions of struggling banks are producing record profits due to negative goodwill ‘bargain purchase gains’. The Q1 2023 earnings of Citizens Bank was $9,504m compared with $264m in the same period last year, largely due to its Silicon Valley Bank deal. Negative goodwill arising from business combinations is reported as an immediate profit under both IFRS and US GAAP; but does it really represent an increase in shareholder value? We explain the meaning of negative goodwill, its releva...| The Footnotes Analyst
Swiss pharma company Novartis provides investors with its own calculation of an EV/EBITDA multiple. However, in our view, the EV is inconsistent with EBITDA. We review the company’s calculation and suggest amendments to ensure it better captures the value of Novartis’ core business. To derive useful valuation multiples, you must be consistent. Our main adjustment to the Novartis calculation relates to the value of their stake in fellow Swiss pharma company Roche.| The Footnotes Analyst
Target valuation multiples that are implied by key value drivers are a great way to better understand equity valuation and how the characteristics of a company affect value. The approach incorporates the same links with underlying value drivers on which DCF is based, but in a simplified way that is more intuitive than a full DCF model. Our target multiple model can be used to estimate a deserved valuation multiple for a company, sector or index, to reverse engineer returns or growth implied b...| The Footnotes Analyst
Amazon provides investors with three alternative calculations of a free cash flow metric. For 2018 these range from $8.4bn to $19.4bn. In contrast our preferred approach gives a negative free cash flow of $3.4bn. What explains these material differences? The disclosures by Amazon about its free cash flow measures are good and the calculations go further than many other companies. However, in our view important components are missing. We explain our additional adjustments in respect of leased ...| The Footnotes Analyst
Considering the market’s focus on earnings, other comprehensive income (OCI) can be easily overlooked by investors. We think OCI is always important in equity analysis, but if you use a residual income approach to valuation the requirement for a ‘clean surplus’ in your model makes it vital to consider gains and losses reported outside profit and loss. We explain clean surplus accounting and why residual income valuations only work if your forecast financial statements meet the clean sur...| The Footnotes Analyst
Companies that use property assets in their business may adopt very different real-estate strategies. Ownership versus leasing and the choice of different lease structures can significantly impact key performance and valuation metrics. We show that separating the operating and property components, using ‘Opco-Propoc’ analysis, improves comparability. Some investors argue that the new IFRS 16 lease accounting reduces comparability. We disagree. In our view IFRS 16 reveals important differe...| The Footnotes Analyst
Discounted cash flow and similar valuation methods are often cited as the only way to derive an intrinsic value of an equity investment that does not depend on how other assets are priced by the market. In contrast, valuation multiples, such as a price earnings ratio or EV/EBITDA, merely identify value relative to other assets. However, this view is not only simplistic - both DCF and valuation multiples can be used in a so-called absolute and relative sense – but it can also be incorrect....| The Footnotes Analyst
Defined benefit pension schemes create two leverage effects - financial leverage due to the debt like nature of pension deficits and asset allocation leverage if pension assets are not matched with pension liabilities. In DCF valuation these effects must be correctly, and consistently, included in both the discount rate and free cash flow. We use an interactive model to demonstrate four possible DCF approaches based on enterprise and equity cash flows. Our preferred approach is based on enter...| The Footnotes Analyst
US GAAP and IFRS present the effects pension leverage differently in financial statements, notably leverage arising from pension fund asset allocation. This complicates the comparison and interpretation of performance measures and valuation multiples. We use Delta Air Lines to illustrate the positive impact of the US GAAP ‘expected return’ approach on reported profit, including the effect of optimistic return assumptions. If Delta had applied the IFRS ‘net interest’ approach we estima...| The Footnotes Analyst
One of the errors we encounter when reviewing DCF models concerns valuation date and cashflow timing adjustments. Although the effect may not always be that material, getting these adjustments wrong undermines the credibility of DCF valuations. We explain the correct application of valuation date adjustments, the necessary amounts for the enterprise to equity bridge, and how to roll-forward values to derive 12-month price targets. We also provide a downloadable model to illustrate these diffe...| The Footnotes Analyst
The mark-to-market of commodity supply contracts, such as power purchase agreements and related derivatives, can create significant volatility in profit and loss. But are these gains and losses meaningful, and should you remove them from performance measures as many companies do in their non-GAAP reporting? There are 4 methods of accounting for power purchase agreements and, confusingly, you could find all of them applied by one company. We explain how each method works, when fair value gains...| The Footnotes Analyst
Most deferred tax adjustments in financial statements help investors - but not always. The ‘economic value’ of deferred tax assets arising from unused tax losses may be significantly less than the balance sheet figure. However, as a consequence, profit forecasts may be understated, potentially leading to an undervaluation by investors. We estimate that if the £24bn deferred tax asset of Vodafone were discounted to an economic value then it would instead be closer to £8bn, but forecast p...| The Footnotes Analyst
Whether you view Bitcoin as a modern-day tulip bulb mania bubble, that will inevitably burst, or an unstoppable development in finance, one thing is certain, companies are increasingly purchasing this asset. But how do Bitcoin and other cryptocurrencies affect reported financial position and performance metrics? There are no accounting rules dedicated to cryptocurrencies. Under current US GAAP and, usually under IFRS, intangible asset accounting is applied. We use the reporting by MicroStrate...| The Footnotes Analyst
Most investors make extensive use of operating profit to assess company performance and as a starting point for valuation. But operating profit, like many company-provided subtotals, is not defined by IFRS; it is largely up to companies to decide what subtotals to include and even what to call them. However, the IASB may soon bring an end to this operating profit ‘free for all’. The proposal will lead to significant changes to the presentation of financial statements, notably the income s...| The Footnotes Analyst
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 suggest how to 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 o...| The Footnotes Analyst
A change in accounting, such as the introduction of IFRS 16, does not in itself change underlying economics. It follows that equity values derived from DCF models should also be unchanged. However, the IFRS 16 lease accounting changes seem to be creating some confusion. We explain how to correctly adjust your DCF calculations and provide an interactive pre and post lease capitalisation model to illustrate. IFRS 16 makes DCF analysis easier and less prone to error; leaving your model based on ...| The Footnotes Analyst
You might assume that a change in enterprise value completely accrues to equity investors; however, this is often not the case. Other claims, such as debt or equity warrants also change in value as enterprise value changes. Understanding this effect can be important when analysing many companies, but especially those in financial distress. Option-like characteristics of debt and equity claims drive the allocation of changes in enterprise value between debt and equity investors. We apply an in...| The Footnotes Analyst
Convertible bond issuance is at a record high, with companies ‘benefiting’ from low interest rates and high equity volatility. However, convertibles are not the cheap form of financing that is sometimes claimed, nor do we think that so-called ‘hedging’ transactions, which often accompany convertible issues, create value for investors.| The Footnotes Analyst
Reported operating cash flow, leverage and net working capital measures, may be misleading if a company engages in supply chain financing. The impact can be significant but, at present, calculating the effect and making adjustments is difficult. Additional IFRS disclosures proposed by the IASB will help. We explain the new disclosures and provide an interactive model to illustrate how to use them to calculate more realistic measures of cash flow, leverage and working capital. The adjustments ...| The Footnotes Analyst
Assets measured at cost are subject to impairment testing and potential write-down if there has been a decline in value. However, unclear impairment indicators, subjective measurement and the ability to use so-called value-in-use may mean that accounting impairments do not equal the change in economic value. We discuss the impairment process for investments in associated companies that are subject to equity accounting. In the case of French media company Vivendi’s investment in Telecom It...| The Footnotes Analyst
There is a particular gain or loss in the income statement of many companies that, in our view, is irrelevant to investors. Fortunately, it is gradually disappearing from most IFRS financial statements due to the introduction of IFRS 9. However, if you invest in insurance companies you might not be so lucky. Chinese insurer Ping An's pre-2018 results were significantly impacted. But no longer - the company is one of the few IFRS reporters in the global insurance sector where investors now ben...| The Footnotes Analyst
Once every decade or so accountants fret over goodwill and reconsider how best to report it in financial statements - should it be amortised, impaired, amortised and impaired, or something else? There is no obvious right answer, positions are entrenched, and debate usually gets nowhere. The problem is that neither amortisation nor impairment provides much help for investors. The debate needs to move on to what really matters – reporting about business value. There are already encouraging mo...| The Footnotes Analyst
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 m...| The Footnotes Analyst
The number of alternative valuation multiples can seem endless. Many different metrics, such as EBITDA and EPS, can be combined with different measures of value, such as the stock price and enterprise value. But there is a further variation that sometimes gets overlooked – the pricing basis. Valuation multiples can be based on a historical price (or EV), a current price, or the less commonly used forward price. We advocate greater use of forward priced multiples. They are more comparable an...| The Footnotes Analyst
Few people seem to be satisfied with intangible asset accounting; depending on your perspective, there is either not enough or far too much of it. What is clear is that many valuable intangible assets go unrecognised in financial statements. The result is distorted financial ratios, including price to book. The lack of intangible asset recognition means that most investors know to use book value with caution. This may not be the case for index providers, ‘smart beta’ funds and quant-based...| The Footnotes Analyst
In the alphabet soup of investment metrics, a new variant on EBITDA has appeared in some IFRS based company presentations – EBITDA-AL, with the ‘AL’ meaning ‘after leases’. But does the new measure make any sense? And why use EBITDA-AL rather than the established EBITDA or EBITDAR? All ‘earnings-before’ measures create comparability issues, omit key components of operating performance, and should be interpreted with caution. We think EBITDA-AL is worse than EBITDA, which never w...| The Footnotes Analyst
Limited disaggregation of income and expense items with different characteristics impair 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 ...| The Footnotes Analyst
The problem with cash flow statements is that ... they only include cash flows. This may seem odd, given that the purpose of cash flow statements is simply to report cash movements. However, most cash flow analysis is focused on sub-totals and it is here that offsetting flows arising from non-cash transactions become important. We explain why adjustments are required and for which transactions you should adjust.| The Footnotes Analyst
Do you invest in both IFRS and US GAAP reporters? If so, then in recent financial statements you might have noticed differences in the accounting for leases. This could result in a significant lack of comparability in key metrics. Both IFRS and US GAAP now better reflect the economics of leasing and so the old adjustments to capitalise operating leases are no longer necessary. Unfortunately, you now need to make other adjustments to get comparability between US and IFRS reporters. We expla...| The Footnotes Analyst
Valuation methods based on enterprise value have become the benchmark in equity valuation. Most of you will have analysed equity investments using valuation multiples based on a market enterprise value or have applied absolute valuation methods to derive a target enterprise value. In simplistic terms enterprise value is market capitalisation plus net debt; but is that good enough? In many situations we think not. We review the key building blocks of enterprise value to assist you in deriving ...| The Footnotes Analyst
The inconsistent and incomplete recognition of intangible assets in financial statements distorts performance metrics. Invested capital and profit are understated - to what extent depends on the business dynamics and nature and source of investment in intangibles. The combined effect is generally to overstate return on capital. With the ever-increasing importance of intangible assets, few companies are unaffected by this accounting problem. We suggest adjustments to help your analysis, provid...| The Footnotes Analyst
Losses caused by the rise in interest rates in 2022, coupled with inadequate interest rate risk management, appear to be the trigger for the collapse of Silicon Valley Bank. However, most of the losses on its fixed rate assets were not recognised in either the balance sheet or in profit and loss. We discuss why investors may have thought the bank was better hedged against interest rate risk than turned out to be the case, and show how 2022 profit would have been very different when measured o...| The Footnotes Analyst
If a valuation multiple, such as EV/EBITDA, is used to calculate a DCF terminal value, the multiple should reflect expected business dynamics at the end of the explicit forecast period and not at the valuation date. This is best achieved by basing the exit multiple on forward-priced multiples for the selected group of comparable companies. We explain and illustrate with an interactive model the use of forward-priced multiples in DCF. We also discuss the choice of multiple (including why EV/EB...| The Footnotes Analyst
If DCF terminal values are based on continuing forecast cash flow, it is important that the reinvestment assumption is consistent with long-term return expectations. We provide an interactive DCF model that demonstrates four alternative cash flow growth-based terminal value calculations, along with related returns analysis. One of the challenges when using returns in equity valuation is the limited recognition of intangible assets. Adjustments to capitalise intangible investment do not change...| The Footnotes Analyst
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...| The Footnotes Analyst
Deferred tax can have a significant impact on the tax charge and hence net income. Although confusing and complex, we think that deferred tax provides very| The Footnotes Analyst
Taxation is a significant expense for most companies and an important driver of profitability and value. Differences in the effective tax rate matter in equity analysis, but how should you calculate this metric and what rate should you use as a basis for forecasting? We explain the different calculations of effective tax rates, why it is important to examine the tax rate reconciliation footnote, the impact of exceptional gains and losses, and how intangible amortisation complicates the analys...| The Footnotes Analyst
There is usually at least one metric that gives valuation-based support for an investment, even if this is contradicted by other indicators of relative or absolute value. You may have heard comments such as “… but it looks cheap on EV/EBITDA” to help justify a particular investment recommendation. We examine why different multiples can give conflicting indications of relative value. For example, food-on-the-go stock Greggs trades at a 35% discount to rival Dominos Pizza, based on EV/EBI...| The Footnotes Analyst
A hidden conservative bias in the form of ‘prudent’ reserving has previously been a common feature of insurance accounting. This practice has made analysing the performance of insurance companies extremely difficult for investors. Hidden prudence is eliminated under the new IFRS 17 and the allowance for insurance risk in measuring liabilities should be fully transparent. However, considering some recent company presentations, we wonder whether this benefit for investors will be fully real...| The Footnotes Analyst
Stock-based compensation can have a significant impact on the effective tax rate. For US companies the effect is driven to a large extent by changes in the stock price. In 2021 this reduced the effective tax rate for many companies; however, in 2022 you could well see the reverse. We use Netflix to explain the effect of stock-based compensation on cash taxes and deferred tax adjustments. The accounting is complex and made even more challenging for investors by differences between IFRS and US ...| The Footnotes Analyst
The profit of insurance companies that report under IFRS is affected by three rates of return – the liability pricing rate, the return from investments, and the IFRS 17 discount rate. The first two largely determine the magnitude of aggregate profit; the last mainly affects the timing of profit recognition and its classification as a service result or net financial result. We use an interactive model to explain how interest rates determine the reported results of insurance companies. The il...| The Footnotes Analyst
Non-GAAP measurers, 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 calcula...| The Footnotes Analyst
IFRS 17 will result in significant changes to insurance company financial statements as of next year. Benefits for investors include a more relevant top line, consistent profit recognition, source of earnings analysis, updated assumptions, value of new business disclosures and an end to confusing asset-based discount rates. We think IFRS 17 will make insurance financial statements accessible to the broader investment community rather than just insurance specialists. However, compromises and o...| The Footnotes Analyst
A largely cost-based measurement approach in financial reporting generally provides sufficient information about operating ‘flows’ to enable investors to apply enterprise value based DCF (or DCF proxy) valuation models. However, fair values are crucial for the ‘bridge’ from enterprise to equity value. Fair values are available for many, but not all, of the assets, liabilities and equity claims that should be included in the enterprise to equity bridge. We explain the limitations of cu...| The Footnotes Analyst
Changes to convertible bond accounting under US GAAP will mean higher reported debt but, paradoxically, a lower (and sometimes zero) interest expense. In our view, the resulting increase in earnings is artificial, fails to faithfully represent the cost of convertible financing and will not benefit investors. The recent surge in convertible issuance, and the use of so-called convertible bond hedges, may have more to do with favourable accounting than favourable economics. We use the recent con...| The Footnotes Analyst
Companies are continuously reshuffling their business portfolio by either spinning off assets (GlaxoSmithKline, Vivendi) or increasing their share in existing businesses (BMW, Siemens Energy). However, the M&A accounting applied to these transactions can produce some unusual and potentially confusing effects. In 2022, German luxury car manufacturer BMW increased its stake in its Chinese joint venture BMW Brilliance from 50% to 75%. Surprisingly, this produced a gain in profit and loss (even t...| The Footnotes Analyst
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 current period changes. Limited disclosure in financial statements makes forecasting this ex...| The Footnotes Analyst
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 b...| The Footnotes Analyst
The capitalised lease liability of an inflation-linked lease does not include expected inflation. This results in a lower liability and lower initial expense compared with an equivalent lease with no inflation link. The IFRS 16 figures are updated as the inflation uplift occurs, but these catch-up adjustments create a profit ‘headwind’. We estimate that Tesco’s inflation linked leases result in a pre-tax profit headwind of about 2.2 percentage points of growth. If inflation were include...| The Footnotes Analyst
DCF based values can be analysed between a current operating value and the value created by short-term growth, medium-term investment, and long-term franchise factors. We provide an interactive value analysis model and explain how this can help in understanding and refining DCF valuations, particularly if combined with adjustments in respect of intangible investment. DCF value analysis gives more insight than the common split between the present value of cash flows in an explicit forecast per...| The Footnotes Analyst
Investors are paying increased attention to risks and opportunities arising from sustainability related issues, particularly the effects of climate change and related ‘net-zero’ commitments made by many companies. Some sustainability risks directly affect financial statements, but you need to look further when considering inputs for equity valuation. Risk affects different aspects of equity valuation. It is well known that risk factors affect the discount rate, but the impact on other val...| The Footnotes Analyst
Although we generally prefer an enterprise value based approach, earnings and price earnings ratios remain an important and legitimate component of equity analysis and valuation. Earnings based analysis includes the earnings per share enhancement or dilutive effects of major transactions. We discuss the value relevance of earnings enhancement or dilution arising from new capital bring raised and invested, with a focus on rights issues. In an earnings-based approach to analysis, it is importan...| The Footnotes Analyst
We often see investors using cash flow metrics, particularly cash from operations, as a measure of performance. Cash flow may even be preferred to profit because it is supposedly more reliable and less subject to management judgement and potential manipulation … “cash is a fact, but profit is an opinion”. We explain why cash flow may not provide the insights into performance that some investors expect, and how cash flow can often be managed even more freely than profit. Cash flow is nev...| The Footnotes Analyst
Many companies look beyond straight debt and ordinary shares when raising finance, with capital structures increasingly including an array of complex financial instruments. This presents challenges for investors, particularly when analysing performance and leverage. We investigate the effects of one form of ‘hybrid’ financing - perpetual super-subordinated bonds – where securities with debt-like features may be reported as equity in financial statements. Recent proposals by the IASB to ...| The Footnotes Analyst
The IASB will shortly issue its new international standard for the presentation of financial statements - IFRS 18. Changes that will benefit investors include a prescribed operating-investing-financing structure for the income statement, new defined subtotals, additional disaggregation, and a more relevant cash flow presentation. IFRS 18 will better align financial reporting with equity analysis and provide additional and more comparable data to facilitate that analysis, including data that s...| The Footnotes Analyst
DCF valuation models can either be based on free cash flow attributable to equity investors or the free cash flow available for all providers of finance. Each requires a different approach to allowing for financial leverage, including adjustments to beta and recognition of the debt interest tax shield. We present an interactive DCF model that illustrates discounted equity cash flow and discounted enterprise cash flow using both the WACC and APV methods. Understanding each approach helps...| The Footnotes Analyst
It can be observed that higher financial leverage increases equity beta. However, the relationship between the unleveraged asset or enterprise beta (the beta of the underlying operating business), and leveraged equity beta that is commonly applied in practice, is incomplete. We explain the relevance of asset betas in equity valuation and why it is important to analyse the beta of debt finance and the value, and riskiness, of the debt interest tax shield when delevering and relevering equity b...| The Footnotes Analyst
The fact that the cost of debt finance is tax deductible, whereas the cost of equity is not, seems to give a structural advantage to debt finance. The value (if any) of this ‘tax shield’ is either an explicit or more likely implicit component of any equity valuation. The most commonly quoted calculation of the value of the debt interest tax shield understates value by ignoring growth but overstates value by ignoring the effect of personal taxes. We explain how to incorporate these often-i...| The Footnotes Analyst
In many transactions the amount payable may not be not known until sometime after the related asset, liability, income or expense is recognised in financial statements. In some cases, the accounting for this ‘variable consideration’ is clearly specified by IFRS. However, in others, including the purchase of fixed assets, companies are free to adopt different approaches. Intangible assets arising from football player transfers are a good example of where companies can apply different accou...| The Footnotes Analyst
The underlying rationale and conceptual basis for the equity method of accounting for investments in associates is unclear. Equity accounting can be regarded as either the cost-based measurement of an investment or as a quasi (one-line) form of consolidation – but neither is particularly helpful for investors. We explain the limitations of the equity method and advocate measuring all investments in associates at fair value, consistent with other minority equity holdings. This results in a m...| The Footnotes Analyst
Equity beta is a valid measure of investment risk and an important metric in equity analysis. However, don’t just plug into your models the equity beta given by a data provider - beta should be analysed and adjusted by investors with the same diligence that is applied to performance metrics. We present an interactive equity beta analysis model to assist investors in better understanding the drivers of equity beta and its application in equity valuation. The model features the calculation of...| The Footnotes Analyst
Following the 2008 financial crisis, loan loss provisioning was changed to reflect ‘expected’ losses rather than ‘incurred’ losses. This made the impairment reserves of banks more responsive to changes in credit quality, but it also introduced a distorting day 2 effect. Under US GAAP most expected loan losses are charged to profit up front. This ‘prudent’ approach may be liked by banking regulators, but it can produce performance metrics that are confusing for investors. The disto...| The Footnotes Analyst
Residual income based valuations are a useful alternative to the more common discounted cash flow. While both approaches must produce the same answer for a given set of assumptions and value drivers, we think it can be easier to derive realistic inputs using the residual income approach, considering the focus on return on investment. However, residual income also poses challenges. The approach requires ‘clean surplus’ accounting, return inputs must allow for accounting distortions due to ...| The Footnotes Analyst
Investors require financial data that is comparable over time, comparable within a single set of financial statements, and comparable between companies. Unfortunately, this is not always the case. We explain how differences between IFRS and US GAAP, accounting policy options, differing interpretations and accounting estimates, can all reduce comparability. Convergence and comparability should be a priority for the IASB and FASB. Present consultations by the IASB and FASB regarding the account...| The Footnotes Analyst
