Corporate Taxes

Back in the 1940s Graham suggested that to ensure that management is honest about earnings, corporations should make income tax statements available to investors upon request.

• If the company paid taxes on income, then it is genuine income.
• If the company didn't, there must be a logical reason, such as a tax write-off or the use of some type of tax credit.  

Corporate taxes have become progressively complex over the years, and only the most dedicated investors - and ones with a lot of time to kill - would care to pore over corporate tax statements.

Fortunately, many corporations now include summary tax information in their annual reports to shareholders.

Many investor information services also supply simplified income tax information in their stock reports.

Reporting of earnings on an after-tax basis is standard practice and to most people, the "real bottom line" is the profits after tax.


Comment:
When the company reported an effective tax rate that is lower than the normal, you may wish to know the reasons for this.  Perhaps, the company has a tax write-off or tax credit that year.

Earnings Made by Tax Rate Changes

Earnings Made by Tax Rate Changes
Wall Street is infatuated with EPS. If a company beats their estimates, the stock price is pushed up higher despite the fact that earnings is so easily manipulated by different accounting methods and hiding and/or delaying expenses.

Taxes also play a big role in the final EPS.

A company with a 40% tax rate one year, paying at 35% the next will create the illusion that growth has exceeded expectations, when in fact, the business did nothing but just get a tax break. The opposite is the same.

A company paying 35% in taxes and then 40% the next year will obviously report lower EPS and the consensus will be that the business is slowing down.

How to Calculate EPS Due to Tax Rate Change

Let’s use Boeing (BA: 67.24 0.00%) as an example.

1. Calculate the tax rate

To calculate the tax rate of a company, find the income tax expense on the income statement and divide by the Earnings Before Income Taxes (EBIT).



Boeing’s tax rate was 33.7%, 33.6% and 22.9% in 2007, 2008 and 2009 respectively.

2. Calculate the difference in tax rates

Just subtract the previous year tax to the next year tax rate.

3. Calculate the gain or loss due to difference in taxes

Use the difference in tax % compared to the last period and multiply it by the income before tax (EBIT) number.

In BA case for 2009, multiply 10.7% and $1,731m to determine how much of EBIT was due to a lower tax rate.



You can see that BA made $185m in EBIT due to taxes compared to $4.16m the year before. In 2007, Boeing’s tax rate increased by 2.7% which is why the % difference is negative and shows a loss due to difference in tax.

4. Divide by Shares Outstanding and Adjust the EPS

Divide the gain or loss due to tax change by the number of diluted shares.



You can now see that in 2009, of the full year diluted EPS, $0.26 was made up due to a reduction in taxes. So while the market may have seen this as a great recovery, the actual EPS was actually $1.58.

Multiply the current PE of 36 to $1.58 and the stock price should be at $56.

The above method can be applied to quarterly results for comparisons and basically any other line item including non-operating and non-recurring expenses.

Let’s wrap things up with a stock valuation summary of Boeing for those that hold the company.

Jae Jun


[www.oldschoolvalue.com]