Income Tax Distortion

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Core Earnings[1] measure the normalized operating profitability of a business by removing any non-recurring gains/losses included in GAAP results to provide a more reliable measure of profits proven to generate novel alpha.

Removing such non-recurring gains/losses has implications for the “true” tax rate a company pays as well. We remove the tax impact of non-recurring items to calculate a company’s true cash taxes to provide a clearer picture of a company’s profitability. To make this adjustment, we remove Income Tax Distortion as part of our calculation of Core Earnings.

Income Tax Distortion = Income Tax – Cash Taxes on Core Earnings

Where Cash Taxes on Core Earnings equal:

Pre-tax Core Earnings X Cash Tax Rate

To calculate a firm’s cash tax rate, we use a three-year normalized rate based on reported taxes adjusted for annual changes in reserves. Cash taxes on Core Earnings estimate the cash taxes attributable to the operations of the business. More details are here.

[1] The Journal of Financial Economics proves that only Core Earnings enable investors to overcome the flaws in legacy fundamental data.


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