Core Earnings

Core earnings are the profits derived for the primary business of a company. It doesn’t take into consideration a number of the expenses associated with the most activities, similarly as nonrecurring income or expense items that lie outside of the conventional business.  Generally accepted accounting principle (GAAP) rules don’t take into consideration core earnings as a reportable metric.

The concept of core earnings was developed by Standard & Poor’s (S&P) in order to measure the income a company generates from its daily operations. In this respect, core earnings include income generated by a company’s production operations, advertising campaigns, and issuance of securities. Core earnings exclude such factors as gains from a firm’s portfolio and pension plan, capital gains from asset sales, and any income derived from a brief project.

The purpose of evaluating core earnings is for management and investors to determine the profitability of a company’s main business and to divest of any non-essential activities and to find related opportunities.

To illustrate, suppose Company XYZ produces watches. Company XYZ’s core earnings will derive from revenue generated by the method of producing the watches, XYZ’s effort to advertise the watches, and therefore the sale and servicing of the securities it issued to raise money to keep up watch-making operations.

Accounting statements contain earnings related to normal business activities, likewise as those related to nonrecurring or side items. Core earnings eliminate noise within the profit and loss (P&L) statement by removing line items like extraordinary gains or losses during a period, restructuring charges, write-downs for impairments, income, or losses from equity-accounted investments, and charges for discontinued operations.

Accordingly, when calculating core earnings, analysts should strip out any gains/losses that are non-core, non-operating, or unusual.

Calculate Core Earnings:

Total Revenue

+ Total Operating Income

– Total Reported Operating Expenses, Net

+ Total Hidden Non-Operating Expense, Net

– Reported Interest Expense / (Income), Net

– Reported Losses / (Income) from Unconsolidated Subsidiaries, Net

+ Goodwill Amortization Expense, Net

– Unreported Employee Stock Option (ESO) Expense

– Cash Taxes on Core Earnings

– Reported Minority Interest Expense, Net

– Reported Preferred Dividends, Net

– Reported Dividends on Redeemable Preferred Stock, Net

= Core Earnings

The company could take action to dampen the volatility by, for instance, getting eliminate an asset that has caused an impairment loss or a restructuring charge. For investors, seeing core earnings enhances their capacity for valuation analysis and relative value analysis of the core earnings of companies within the same sector.

Core earnings will also help investors make adjustments to price multiples such as price-to-earnings ratio (P/E), price-to-forward earnings (Forward P/E), price-to-cash flow ratio (P/CF), and others, but instead of “P/E,” for instance, “Core P/E” will become the metric of focus.

Core earnings reflect income generated by what may be called “business-as-usual.” Because it excludes any one-time events or market fluctuations, it will be a more robust indicator of a company’s earnings performance across numerous accounting periods.

 

Information Sources:

  1. investinganswers.com
  2. investopedia.com
  3. seekingalpha.com