much as possible, I have adjusted the profit figures to exclude non-recurring profits and losses, which are often referred to as significant items. It is for this reason that the profit figures in Top Stocks sometimes differ from those in the financial media or on financial websites, where profit figures normally include significant items.
Significant items are those that have an abnormal impact on profits, even though they happen in the normal course of the company's operations. Examples are the profit from the sale of a business, or losses from a business restructuring, the write-down of property, an inventory write-down, a bad-debt loss or a write-off for research and development expenditure.
Significant items are controversial. It is often a matter of subjective judgement as to what is included and what excluded. After analysing the accounts of hundreds of companies, while writing the various editions of this book, it is clear that different companies use varying interpretations of what is significant.
Further, when they do report a significant item there is no consistency as to whether they use pre-tax figures or after-tax figures. Some report both, making it easy to adjust the profit figures in the tables in this book. But difficulties arise when only one figure – generally pre-tax – is given for significant items.
In normal circumstances most companies do not report significant items. But investors should be aware of this issue. It sometimes causes consternation for readers of Top Stocks to find that a particular profit figure in this book is substantially different from that given by some other source. My publisher occasionally receives emails from readers enquiring why a profit figure in this book is so different from that reported elsewhere. In virtually all cases the reason is that I have stripped out a significant item.
Earnings per share is the after-tax profit divided by the number of shares. Because the profit figure is for a 12-month period the number of shares used is a weighted average of those on issue during the year. This number is provided by the company in its annual report and its results announcements.
The cash flow per share ratio tells – in theory – how much actual cash the company has generated from its operations.
In fact, the ratio in this book is not exactly a true measure of cash flow. It is simply the company's depreciation and amortisation figures for the year added to the after-tax profit, and then divided by a weighted average of the number of shares. Depreciation and amortisation are expenses that do not actually utilise cash, so can be added back to after-tax profit to give a kind of indication of the company's cash flow.
By contrast, a true cash flow – including such items as newly raised capital and money received from the sale of assets – would require quite complex calculations based on the company's statement of cash flows.
However, many analysts use the ratio as I present it, because it is easy to calculate, and it is certainly a useful guide to how much funding the company has available from its operations.
The dividend figure is the total for the year, interim and final. It does not include special dividends. The level of franking is also provided.
The NTA-per-share figure tells the theoretical value of the company – per share – if all assets were sold and then all liabilities paid. It is very much a theoretical figure, as there is no guarantee that corporate assets are really worth the price put on them in the balance sheet. Intangible assets such as goodwill, newspaper mastheads and patent rights are excluded because of the difficulty in putting a sales price on them, and also because they may in fact not have much value if separated from the company.
As already noted, some companies in this book have a negative NTA, due to the fact that their intangible assets are so great, and no figure can be listed for them.
Where a company's most recent financial results are the half-year figures, these are used to calculate this ratio.
The interest cover ratio indicates how many times a company could make its interest payments from its pre-tax profit. A rough rule of thumb says a ratio of at least three times is desirable. Below that and fast-rising interest rates could imperil profits. The ratio is derived by dividing the EBIT figure by net interest payments. Some fortunate companies have interest receipts that are higher than their interest payments, which turns the interest cover into a negative figure, and so it is not listed.
Return on equity is the after-tax profit expressed as a percentage of the shareholders' equity. In theory, it is the amount that the company's managers have made for you – the shareholder – on your money. The shareholders' equity figure used is an average for the year.
This ratio is one of the best-known measures of a company's debt levels. It is total borrowings minus the company's cash holdings, expressed as a percentage of the shareholders' equity. Some companies have no debt at all, or their cash position is greater than their level of debt, which results in a negative ratio, so no figure is listed for them.
Where a company's most recent financial results are the half-year figures, these are used to calculate this ratio.
The current ratio is simply the company's current assets divided by its current liabilities. Current assets are cash or assets that can, in theory, be converted quickly into cash. Current liabilities are normally those payable within a year. Thus, the current ratio measures the ability of a company to repay in a hurry its short-term debt, should the need arise. The surplus of current assets over current liabilities is referred to as the company's working capital.
Where a company's most recent financial results are the half-year figures, these are used to calculate this ratio.
The tables for the banks are somewhat different from those for most other companies. EBIT and debt-to-equity ratios have little relevance for them, as they have such high interest payments (to their customers). Other differences are examined below.
Operating income is used instead of sales revenues. Operating income is the bank's net interest income – that is, its total interest income minus its interest expense – plus other income, such as bank fees, fund management fees and income from businesses such as corporate finance and insurance.
Banks borrow money – that is, they accept deposits from savers – and they lend it to businesses, homebuyers and other borrowers. They charge the borrowers more than they pay those who deposit money with them, and the difference is known as net interest income.
These are all the costs of running the bank. Banks have high operating expenses, and one of the keys to profit growth is cutting these expenses. Add the provision for doubtful debts to operating expenses, then deduct the total from operating income, and you get the pre-tax profit.
Banks have traditionally made most of their income from savers and from lending out money. But they are also working to diversify into new fields, and this ratio is an indication of their success.
As noted, the banks have high costs – numerous branches, expensive computer systems, many staff, and so on – and they are all striving to reduce these. The cost-to-income ratio expresses their expenses as a percentage of their operating income, and is one of the ratios most often used as a gauge of efficiency. The lower the ratio drops the better.
Banks have enormous assets, in sharp contrast to, say, a high-tech start-up whose main physical
