Accounting Visualized™
Following the same methodology as Part 1 of this series, we now look at Residual Income for Mid Caps. As absolute amounts are small, the reviews for mid and small caps will only look at amounts scaled by market cap.
TTM Residual Income Descending % of Market Cap – Mid Cap
The Japan Analytics App uses Residual Income as the key component in its valuation model. For many this is an unfamiliar concept which this post will try to address.
Residual Income which is also known as ‘economic earnings’ represents the true value generated for shareholders after taking into account their required return. Traditional accounting was originally designed for debt investors and does not include a charge for the use of equity capital. Shareholders are left to determine on their own if their opportunity cost has been covered.
Companies that do not generate excess or residual income over their required return should be considered as destroying shareholder value and should be valued at below book. Companies that create value should trade at a premium.
Calculating Residual Income requires a number of adjustments to be made to the Income Statement and Balance Sheet in order to derive “Core Operating Income” and “Net Operating Assets”. For most companies the former is equal to Gross Profit less SG&A expenses but after an allocation of tax, while the latter requires a separation of operating and financial assets and liabilities. Operating activities are primarily trading with customers and suppliers in goods and services but also include investments in inventories and fixed assets. Financial activities include the raising of cash from and returning of cash to debt providers and equity holders and also the investment of any financial surpluses. In most cases only the operating activities add value to a business and for non-financial companies almost all financial activities should be considered to have zero net present value.
Rather than attempt to calculate a weighted average cost of capital (“WACC”) for each business which can be an exercise in frustration as it requires us to determine the equity risk premium, we have adopted a single required rate of return for all companies of 6%, an amount equal to the long-term rate of return for industrial companies in developed markets.
Residual Income is therefore calculated as follows: –
Core Operating Income After Tax less (Net Operating Assets Y-1 * 6%)
Part 1 of this review will look at Large Cap companies.
Our final results review covers the top and bottom Small-Cap companies by Results Score and three-month change in Results Score.
The Japan Analytics Results Score is a measure of earnings results and earnings momentum which covers the last eight quarters for revenue and operating income.
The score has a maximum of 30 and minimum of -30.
As most of these companies are too small for all but individual investors, the commentary will only mention those companies that have decent upside in the Japan Analytics valuation model.
TOP 20 SMALL CAP COMPANIES RANKED BY RESULTS SCORE 11/17
We continue our analysis be reviewing the performance by company and will review the top and bottom Mid-Cap companies by Results Score and three-month change in Results Score.
The Japan Analytics Results Score is a measure of earnings results and earnings momentum which covers the last eight quarters for revenue and operating income.
The score has a maximum of 30 and minimum of -30.
TOP 20 MID CAP COMPANIES RANKED BY RESULTS SCORE 11/17
The last quarter’s results were the best in four years. We continue our analysis be reviewing the performance by company and will review the top and bottom companies by Results Score and three-month change in Results Score in three cap ranges, Large, Mid and Small.
The Japan Analytics Results Score is a measure of earnings results and earnings momentum which covers the last eight quarters for revenue and operating income.
The score has a maximum of 30 and minimum of -30.
TOP 20 LARGE CAP COMPANIES RANKED BY RESULTS SCORE 11/17
