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The Usefulness Of Alternative Measures Of Profit

1702 words - 7 pages

The purpose of the following report is to examine the relative usefulness of alternative measures of profit (or income) to equity investor and assess the potential contribution of key valuation models. The analysis will include a theoretical research part, containing a synthesis of equity valuation techniques and alternative profit measures. And also a practical part that should illustrates the potential differences in the information conveyed to investors by different profit measures of a NASDAQ company.

Profit measures and valuation models represent the central focus of decision making, therefore it is an important concept to determine and investigate. Managers use valuation techniques and profit measures to monitor and asses the performance of the business relative to competitors and to evaluate financial policies or new investments. Securities analyst uses them to rate companies and generate a strategy that they may recommend to clients. Bankers may use valuation methods with the purpose of deciding whether to extend or terminate a line of credit for a corporation. Investment banker use valuation techniques in order to value and analyse possible buyouts, mergers or acquisitions. Therefore, it is not surprisingly that there is a great demand for a comprehensive and efficient earnings measurement.
Ratio profit measurements and valuation models represent an important topic for the financial literature. Researchers and analysts have developed a variety of equity valuation techniques that may be used by investors in formulating a financial strategy. However, in practice many investors find it difficult to distinguish among different models that may provide unlike and misleading information. Since 1968 in the work of Ball and Brown, it has been stated that the stock prices are closely related to earnings performance. And it has been conventionally measured using the net income and earnings per share (EPS) figures produced according to GAAP². However, more recently investors started evaluating “Street” earnings information conveyed by alternative performance measures (non- GAAP ), such as underlying profits, normalised profit, EBIT , EBITDA , etc. These alternative profit figures often appear in company media releases, analyst briefings and other investor communications.
Most valuation models are based on forecasting techniques of dividends, cash flows, earnings, income or operating profits. A well established and utilized model of valuating a stock is the multiples based method which uses the financial metrics of a company, such as earnings, net assets, and sales. In this type of analysis there are several statistical ratios that may be used: price to book (P/B), price to earnings (P/E), price to sales (P/S), EBITDA and other ratios based on comparable companies. Equity price based multiples are most significant for investors that acquire minority positions in...

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