How do you value a company? It produced fifty million in profits this year, will lose twenty million next year, and probably make over one hundred million the following. Weird earnings streams cause valuation predictions, so the Abnormal Earnings Valuation Model relies on book value more predominantly than prognosticated future earnings when making those calculations. Future earnings are taken into account in the Valuation Model via the Discounted Cash Flow Method (or DCF Method), but the WACC Model, or Weighted Average Cost of Capital Model, is replaced with some dartboard driven estimation of the cost of the firm's equity.
The goal here lies in trying to figure out whether or not company management did a good job deploying the scarce resource of their own capital as they ran the business. So many vagaries exist, however, in the numbers applied to derive a conclusion using this method, that many professionals would prefer the BDD Method, which requires the deployment of a blindfold, a donkey, and a dartboard.
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Finance: What is Earnings Quality?50 Views
Finance allah shmoop What is earnings quality Well it's just
math right Whatever Dot com just produced a dollar thirty
two in earnings One hundred thirty two cents of wall
street Love and profit How can there be a quality
to that number The number is a number right Well
yes but rather there are different qualities of earnings What
if we told you that one hundred percent of whatever
dot coms earnings came from Adsit sold tto forty thousand
different buyers because its website was just that popular All
of the growth came intrinsically meaning that users just loved
using the site and nothing meaningful changed on their balance
sheet or wall street Fancy engineers doing creative clever things
with the selling of money Other than that the cash
account went up because dead profits and they kept him
okay Those air very high quality earnings Really sure about
that C we threw a curveball in there We do
that all the time All right Well what if we
told you that seventy percent of their ad sales came
from a subsidiary in china and were all collected in
our m b the chinese currency and that in this
quarter well that the chinese currency appreciated thirty eight percent
relative to the dollar Well essentially all of their big
growth The big growth that we thought was such high
quality earnings came because the chinese currency did well not
because their business did all that well so wait Had
the chinese currency just been flat the company wouldn't have
earned anything close to a dollar thirty to seventy percent
of the sales and almost forty percent of currency gain
there Well it means that the company happened to have
a lot of sails in a country with a fast
appreciating currency It wasn't necessarily a direct reflection that the
company was doing so well and had such high quality
earnings Yeah it's great that they were in a hot
market and highly appreciating currency but if the currency hadn't
gone up so much relative to the u s dollar
in which they report their earnings toe wall street while
the real urn things end of the company would have
been more like a dollar maybe less so that it
be low quality earnings What about high quality earnings Well
really simply you said you'd sell three hundred tractors this
quarter the street thought you'd sell three hundred ten You
actually sold three hundred twenty you said margins would be
twenty percent The street thought they'd be twenty two percent
and they actually were twenty five percent You said you
generate twenty million dollars in cash the street thought you
generate twenty two and you actually did generate twenty five
million dollars in cash High quality financial results Simple You
just did your core business Selling tractors well Quality earnings 00:02:41.233 --> [endTime] quality tractors
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Normalized earnings are, more or less, the average of what you typically earn. Picture a bell curve. Zoom in on the middle of it. There you go.
