Rates Move Earnings
Earnings per share is all that most investors notice when a company
reports quarterly results. All else equal, share
prices move up when earnings substantially beat forecasts.
Conversely, stocks usually drop
when they fall short.
Few analysts and even fewer individual investors notice the income tax
rate that was a key factor in determining earnings per share. They
should. Here’s why.
Earnings per-share (EPS) is net income divided by the number of shares
out. If a company had net income of $1,000 and 500 shares out, it earned
$2.00 per share.
Why Tax Rates Matter
Here’s the part that most players ignore. You get net income by
subtracting income taxes due from pre-tax income, which is the profit
left after considering all costs except income taxes. Corporations
typically pay taxes amounting to 30% to 40%
of pre-tax income. But sometimes they pay a
lower rate, and reported EPS skyrockets when that happens. Here’s an
Assume that Company A and Company B both earned $1,000 in pre-tax
income, and both had 100 shares out. But they pay different income tax
rates. Company A pays 20% and Company B pays
Here’s how that math works. Company A’s net income is $800 ($1000 minus
$200) compared to $600 for Company B. Thus, even though they both
generated the same pre-tax profit, Company A earned $8.00 per share
($800 divided by 100 shares) compared to $6.00 per share for Company B.
Tax rates always vary from year-to-year and you can see from the
example, even a small change could mean the difference between whether a
company beats or misses earnings expectations.
What Happens Next?
Thus, when you’re analyzing a stock, you need to know its recent
income tax rate, and whether that rate is likely to move up in future
quarters. Fortunately, that’s easy to do. You won’t need your
calculator. You can look up the annual income tax rates going back 10
years for just about any stock on MSN Money (moneycentral.msn.com)
or on Morningstar (www.morningstar.com).
When you look, you’ll see that some firms always pay lower than the
rates because of conditions particular to the company or its industry.
Others, however, may be enjoying a temporary tax break triggered by
recent losses, or for a variety of other reasons.
Where to Get Tax Info
Both Morningstar and
MSN Money display tax rates for each of the past 10 fiscal years,
but Morningstar also displays the rate for the most recent reported four
quarters (TTM or trailing 12-months). Consequently, I’ll describe how to
use Morningstar to look up Internet auction site eBay's numbers.
Enter eBay’s ticker symbol (EBAY) in the quote box on Morningstar’s
home page, and
Key Ratios. Look for the “tax rate” figures in the Profitability
section. When I looked, eBay’s most recent fiscal year (2008) and TTM
rates were 18.5%, far below the 30%
to 40% numbers typical of earlier years.
Not Worth Digging
Finding out why eBay’s recent tax rate is lower than usual
requires some digging. Unless you get lucky with a Google search, you’ll
probably have to read a recent SEC quarterly or annual report to learn
the reason. In my view, it’s not worth the effort.
Undoubtedly, eBay’s tax rate will eventually return to the
historical norms reflected on Morningstar’s report. When that happens,
eBay’s earnings growth rate will take a hit.
In the stock market, nothing works all the time. The fact that a stock
is paying unusually low corporate tax rates signals added risk. It’s no
guarantee that the stock will miss its next quarter’s earnings forecast.