Concept 1: Normal Earnings

Contents - Index

Concept 1: Normal Earnings
©2009 OS Financial Trading System

Normal earnings are earnings that grow at the required rate:
Normal Earningst = Cost of equity capital * Earningst-1

IBM Example: The 10-K filings from IBM provide the source data as follows:

Source 2008 selected parts from the 10-K IBM SEC Filing
From the above the Earnings per share = $12,334/(2,096.981860 - 757.885937) = $9.21
Note on Income Numbers Used
In this exercise we will use Comprehensive income as net income to reflect the significant pension costs for IBM that do not pass through the regular income statement. This is defined as follows:
Comprehensive income = Net income + Other Comprehensive income
In 2008 10-K IBM does not report "Other Comprehensive income" but if looking closer at the changes in the Shareholders' Equity statement in IBM's 2008 10-K reports there is a significant line item ($18,431) that largely arises from net changes in retirement benefit plans ($14,856) and Foreign currency translation adjustments ($3,552).

From the above IBM's Comprehensive Income is actually negative for 2008 because "Other Comprehensive Income" is ($18,431). However, 2008 was the time that that IBM replaced its pension plan with a new and improved 401(k). As a result, we make the following simplifying assumption to adjust for this impact.
Simplifying Assumption: Looking at the last two years the major components of Other Comprehensive Income are $5487 in 2007 and ($18,431) in 2008. If we take the average of these two figures we get ($6472).
The Comprehensive income that we will apply for valuation purposes is:
Comprehensive income = $12,334 + ($6472) = $5862
Comprehensive Earnings per share = $5,862/(2,096.981860 - 757.885937) = $4.37758
In part VI. We will compute the investors' required rate of return to complete the inputs required for Normal Earnings.