Comprehensive Earnings

Companies grow in value when they make a profit … profit that is reinvested on the Balance Sheet to earn greater profits (or paid out to shareholders so they can reinvest). But it is hard to measure a flow (revenues and expenses during a period)… much easier to measure two static values (assets at a point in time) and calculate the difference.

• Analogy: it is easier to measure the volume of a lake (Balance Sheet) at different points in time and then subtract to find the change, than to measure the net volume of streams flowing in and out over a year (Revenue / Expense).
• Analogy: it is easier to measure your kid’s height on every birthday (Balance Sheet) and then subtract to find his growth, than it is to measure his growth directly (Net Income).

This page shows how to calculate a company’s profit using the static Balance Sheet measurements at the beginning and end of the period. Essentially, this is what accountants purport to measure in the Income Statement. But their measure is invalid in two ways.

1. Accountants make changes to the value of Assets and Liabilities without including those changes in the Income Statement. Nor are the changes included in the reported EPS numbers. Instead they are posted directly to the Equity line item called Comprehensive Earnings. Be clear that what is being measured on this webpage differs from what is reported by accountants with that same title.
2. Accountants do not measure management’s decisions to reallocate ownership-interests between new and pre-existing owners. Their profit measures a company’s performance as a whole, not the profit each shareholder gets to keep. A 10 percent growth from operations can be voided by a 10 percent reallocation of ownership-interest to new owners. NOWHERE do companies measure or publish the effects of changes in ownership interest. Even given the extensive data in their notes, the numbers necessary to perform your own calculation are not provided and must be approximated.

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Shareholder Equity on the Balance Sheet measures the net value of all the business’s Assets and Liabilities. Each shareholder’s ownership interest is calculated by dividing Equity by the number of shares outstanding at the measurement date – book value per share. Do not use the average number of shares outstanding over the period that is most commonly disclosed. You can derive a measure of Comprehensive Profit by reconciling the opening and closing value of Shareholder Equity. All the analysis must be done on a ‘per share’ basis in order to incorporate the effects of changing ownership-interest.

Changes in Equity values come from three causes: Comprehensive Profits, Dividends paid out to owners, and the premium resulting from issuing or redeeming shares. You derive the value of the Comprehensive Profits by plugging the values of the other items into a basic equation and solving for the unknown Profit.

Dividends declared : are usually reported in the financials, but it may take some looking. Do not use the $ seen on stock quotes because that will be the expected future payment, not the past year’s. Do not use the Dividends Paid value from the Statement of Cash Flow because there is a lag between declaration and payment, and also because any DRIP dividends are never actually paid.

Premium from Shares Issued : New shares will have a market value (hopefully) greater than the pre-existing book value per share. This premium gets shared by all the resulting shareholders. This increase in the book value per share is not due to management or any business operations. It is a ‘market return’, generated and dependant solely on the market price of the stock. It is equivalent to the capital gain realized if the owner sold the same percent of his shares in the secondary market (discussed in Understand Equity).

You calculate the premium according to the column labeled “Issue Shares” in the diagram above. The proceeds from new shares must be measured as if at market values. When shares are issued to pay for the take-over of another business you can assume they were valued at market. Similarly when shares are repurchased from the market for buy-backs, or issued through brokers into the market. You can use the disclosed value received to calculate the per-share value. This is represented in the right column.

But when shares are issued for the exercise of options the proceeds will be hugely below market value – as shown in the middle column. You must estimate what the market value was. If you know the exercise dates you can look up the market value, but that will take too much time. It is more practical to use an average of the market price for the year, or the value received for share buy-backs.

Adjusting Shareholder Equity : Accounting rules are under the control of business, not the users of Financial Statements. There will be many rules you don’t agree with. These have the effect of wrongly measuring the start and end point of your reconciliation. You must adjust the reported Shareholder Equity for any corrections at each Balance Sheet date. How much time and effort you spend restating the Balance Sheet it up to you.

The biggest error in reported EPS is due to the wrong measurement of stock options (discussed in Understand Equity). Without making any adjustments here, this process will include the cost of options compensation within Comprehensive Profit. But the effect will be lumpy because it only get recognized when the options are exercised. You can fine-tune the effects by making accruals each year for the options’ changing value (as shown in the Stantec example below) but it is not necessary.

Some items missing from reported EPS do not require you to make any further adjustments to your calculation here. These are the items that accountants call ‘comprehensive income’ in the Reports (not the same ‘comprehensive profits’ as you are calculating here). The existing Balance Sheet values are correct already, even though the reported Net Income omitted them. They include:

• foreign exchange gains and losses
• hedging gains and losses
• the effects of changes to the accounting rules retrospectively
• gains and losses on volatile assets that management wants to smooth over a longer period e.g. pension costs
• mark-to-market gains and losses of marketable securities.

Other items you must (if you want) adjust yourself:

• removing or reducing goodwill,
• valuing OilandGas assets at their realizable market value, not their exploration cost,
• changing the pension liability to its unfunded balance.

Example : Automated Calculation

The spreadsheet used to analyze companies includes a rough estimate of the components of Comprehensive Profit. The cost of options is derived using the average share price during the year – which may be quite different from the market value at the time of the options’ exercise. But this is better than nothing.

Example: Stantec (T-STN) Jun 2007

Step 1: Options Liability at Opening/Closing Balance Sheet Dates

# of options * (market value – exercise value) = $000
At Dec 2006: 1,702.784 * ($25.25 – $11.92) = $22,698
At Jun 2007: 1,328.188 * ($35.20 – $13.88) = $28,317

Step 2: Book Value at Opening/Closing Balance Sheet Dates

(Reported – Options / Shares outstanding
At Dec 2006: ($410,895 – $22,698) / 45,201.785 = $8.588 /sh
At Jun 2007: ($419,933 – $28,317) / 45,574.038 = $8.593 /sh

Step 3: Gain from Issue of Shares Above Book Value

Number of shares issued: (354.264 + 17.989) = 372,253
Average market value of shares in period = $30.00
Premium = # shares * (market value – book value)
372.253 * ($30.00 – $8.59) = $7,970
Premium per Share = Premium / shares o/s
$7,970 / 45,574.038 = $0.175 /sh

Step 4: Solve For Comprehensive EPS

While the reported EPS was $0.72 PROFIT, the comprehensive EPS was a $0.17 LOSS. If you do the further math to determine the breakdown of that loss you find:

$0.720 reported EPS
<$0.324> cost of options
<$0.587> FX translation
$0.021 other
<$0.170> Comprehensive Loss

FX Translation: (FX account, Jun07 – FX account, Dec06) / Avg Shares o/s
(51,570 – $24,844) / 45,520.017 = <$0.587 /sh>
Conclude – shareholders need to do their own currency hedging.

Cost of Options:
a)Change in Liability = (Closing bal – Opening bal) / Avg shares o/s
(28,317 – 22,698) / 45,520.017 = $0.123
b)Options exercised = (#sh issued * market value) – $ received) / Jun shares o/s
(372.253 * $30.00) – (1,481 – 330 + 819) / 45,574.038 = $0.201
Change in liability + options exercised =
$0.123 + $0.201 = <$0.324 /sh>
Conclude – management took 45 percent of reported profits for themselves.

Other: Sum of other values through Equity account / Avg sh o/s
($481 + $594 – $136) / 45,520.017 = $0.021 /sh.