Flash Profits: One-time event that impacts earnings

Any one-time event that impacts earnings, such as a gain from the sale of an asset or a one-time loss resulting from a catastrophic event or the write-off of a potential debt, should be lifted out of the earnings figures and set to one side.

These occurrences should be recognized for what they are and judged accordingly.  They are in no way indicative of the outlook for future earnings.

A one-time sale of assets tends to make overall corporate profits look better in the year it occurs.  Yet the sale decreases the total assets of the company.  There is no real gain.

In an established, well-managed company, daily operations finance themselves with cyclical shortfalls covered by short-term borrowing, so never should a one-time gain be used to cover ordinary expenses.  

There is no real gain from the one-time sale of assets unless the money is used for one of the following:

• Restore the asset base
• Reduce debt
• Contribute substantially to future earnings.

What is normalised earnings?

Normal earnings is the maintainable....earnings of the company mah...!

Not exceptional earnings from forex gain,commodity gain, property disposal, one time pay off compensation, stock market gain, court or arbitration awards, accelerated income settlement, revaluation gains.....!

The key is quality of the earnings....!


http://www.investlah.com/forum/index.php/topic,18368.msg341706.html#msg341706

Price-Earning Ratio 101

What actually is PER?

It's often said that the PER is an estimate of the number of years it'll take investors to recoup their money. Unless all profits are paid out as dividends, something that rarely persists in real life, this is incorrect.

So ignore what you might read in simplistic articles and note this down: a PER is a reflection not of what you earn from a stock, but “what investors as a group are prepared to pay for the earnings of a company”.

All things being equal, the lower the PER, the better. 


But the list of caveats is long and vital to understand if you're to make full use of this metric.

PER:  Historical versus Forward or Forecast PER

The PER compares the current price of a stock with the prior year's (historical) or the current year's (forecast) earnings per share (EPS). Usually the prior year's EPS is used, but be sure to check first.

For example:

Last financial year, XYZ Ltd made $8 million in net profit (or earnings). 

The company has 1 million shares outstanding.

So it achieved earnings per share (EPS) of $8.00 ($8 million profit divided by 1 million shares). 

In the current year, XYZ is expected to earn $10 million; a forecast EPS of $10.00.

• At the current share price of $100, the stock is therefore trading on a historic PER of 12.5 ($100/$8). 
• Using the forecast for current year's earnings, the forward or “forecast PER” is 10 ($100/$10).

Quality has a price to match

Quality usually comes with a price to match. 


It costs more, for example, to buy handcrafted leather goods from France than it does a cheap substitute from China. Stocks are no different: high quality businesses generally, and rightfully, trade on higher PERs than poorer quality businesses.





Low PER doesn't alone guarantee quality business

• Value investors love a bargain. Indeed, they're defined by this quality. 
• But whilst a low PER for a quality business can indicate value, it doesn't alone guarantee it. 
• Because PERs are only a shortcut for valuation, further research is mandatory.
• 
  

High PER with strong future earnings growth maybe a bargain

• Likewise, a high PER doesn't ensure that a stock is expensive. 
• A company with strong future earnings growth may justify a high PER, and may even be a bargain. 
• A stock with temporarily depressed profits, especially if caused by a one-off event, may justifiably trade at a high PER. 
• But for a poor quality business with little prospects for growth, a high PER is likely to be undeserved.

Avoid a Common trap: Use underlying or normalised earnings in PER


There's another trap: PERs are often calculated using reported profit, especially in newspapers or on financial websites. 


But one-off events often distort headline profit numbers and therefore the PER. 


Using underlying, or “normalised”, earnings in your PER calculation is likely to give a truer picture of a stock's value.





What is a normalised level of earnings?

That begs the question; what is a normal level of earnings? That's the $64 million dollar question.


 If you don't know how to calculate these figures for the stocks in your portfolio, now is the time to establish whether it's skill or luck that's driving your returns. And if you don't know that, history may well make a monkey of you.




An old encounter with low PE stock: Hai-O


It is nostalgic to re-read an old post on Hai-O by ze Moola. 

http://whereiszemoola.blogspot.com/2008/04/more-on-haio.html

Sunday, April 13, 2008
MORE ON HAIO

My dearest BullBear,

A low PE stock means only one thing and that is the stock is trading on a lower valuation compared to what it is currently earning.

Some simply consider that what is happening is the stock is being ignored in the market despite its impressive earnings.

Why?

The market could be wrong and that perhaps this is a stock that's an ignored gem. Yeah, the classical hidden gem and if this is the case, investors who invests in the stock could be rewarded for their stock selection.

However, on the other hand, sometimes the market could be right and that they do sense something is not right within the stock.

And because of this reasoning, I have always realised that a low PE stock does not make a stock a QUALITY stock.

It just means the stock is trading 'cheaply'.

It could be a bargain but it could also be a trap.

Normalizing Earnings for PE ratios

Normalizing Earnings for PE ratios

The dependence of PE ratios on current earnings makes them particularly vulnerable to the year-to-year swings that often characterize reported earnings.

In making comparisons, therefore, it may make much more sense to use normalized earnings.

The process used to normalize earnings varies widely but the most common approach is a simple averaging of earnings across time.

For a cyclical firm, for instance, you would average the earnings per share across a cycle. In doing so, you should adjust for inflation.

If you do decide to normalize earnings for the firm you are valuing, consistency demands that you normalize it for the comparable firms in the sample as well.

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf