9.3 Concept 1: Normal Earnings

Normal earnings are earnings that grow at the required rate:

Normal Earnings_t = (1+ Cost of equity capital) * Earnings_t-1

IBM Example: In Chapter 1 we downloaded all financial statements for IBM from the 10-K filings for 2009, 2008, and 2007:

Consolidated Statement of Earnings (USD $)
In Millions, except Share data	12 Months Ended Dec. 31, 2009	12 Months Ended Dec. 31, 2008		12 Months Ended Dec. 31, 2007
Net income	$13,425	$12,334		$10,418
Earnings/(loss) per share of common stock, assuming dilution:
Continuing operations (Note R)	$10.01	$8.89	^[2]	$7.15
Discontinued operations (Note R)				$0
Total (Note R)	$10.01	$8.89	^[2]	$7.15
Earnings/(loss) per share of common stock, basic:
Continuing operations (Note R)	$10.12	$9.02	^[2]	$7.27
Discontinued operations (Note R)				$0
Total (Note R)	$10.12	$9.02	^[2]	$7.27
Weighted-average number of common shares outstanding:
Assuming dilution	1,341,352,754	1,387,797,198	^[2]	1,456,880,751

Source: selected parts from the 2009 10-K IBM SEC Filing

From the above the Earnings per share = $13,425/1,341 = $10.01

For this model the concept of earnings applied is Comprehensive income. This is defined as follows:

Comprehensive income = Net income + Other Comprehensive income

In the 10-K statements the last three years for “Other Comprehensive Income” is available in the Stockholders Equity Statement.

Conceptual Note:

In dirty surplus accounting some items are adjusted to the stockholder’s equity as opposed to the income statement. The main three items are: foreign currency translation, pension liability and hedge accounting adjustments. As a result, these items can fluctuate from year to year and so we will take the average over the three years provided in the 10-K as a first pass for “Other Comprehensive Income.”

The three years provided (2009, 2008 and 2007) respectively are:

It is evident that the year to year fluctuations are large. As a result, by taking the average:

Other Comprehensive Income = (3015 +( 18431) + 5487)/3 = (3309.67)

The Comprehensive income that we will apply for valuation purposes is:

Comprehensive income = $13,425 + ($3310) = $10115 million

Comprehensive Earnings per share = $10.115/1.341 = $7.543