This report is one of a series on the adjustments we make to convert GAAP data to economic earnings.

Reported earnings don’t tell the whole story of a company’s profits. They are based on accounting rules designed for debt investors, not equity investors, and are manipulated by companies to manage earnings. Only economic earnings provide a complete and unadulterated measure of profitability.

Converting GAAP data into economic earnings should be part of every investor’s diligence process. Performing detailed analysis of footnotes and the MD&A is part of fulfilling fiduciary responsibilities.

We’ve performed unrivaled due diligence on 5,500 10-Ks every year for the past decade.

In the reports we’ve done so far, we’ve gone through several of the adjustments we make to reveal a company’s core operating profit, or NOPAT. It’s important to understand, however, that the removal of income and expenses has an effect on the true taxes a company pays as well. Without removing the tax impact of non-operating items, one still gets a distorted picture of a company’s operating profitability.

Due to its high number of non-operating expenses, United Parcel Service (UPS) had a low reported income tax expense of only $167 million, and a tax rate of 17.1%. To find its true operating tax rate, we removed the tax benefit (pre-tax value minus post-tax value) of non-operating items where the pre and post-tax values were disclosed (see an example). Removing the tax benefits from the income tax expense and adding the non-recurring expenses back to income gave UPS an effective cash tax rate of 34.8%. Multiply that tax rate by UPS’s pre-tax operating profit of $11.5 billion, and you see its true operating taxes are just over $4 billion.

Figure 1 shows the five companies with the largest (gross value) non-operating tax adjustment to NOPAT for 2012.

Figure 1: Largest Positive/Negative Non-Operating Tax Adjustment

NOTASources: New Constructs, LLC and company filings

These companies are far from the only ones affected by non-operating tax adjustments. In the last fiscal year, 2013 companies had negative adjustments to NOPAT totaling $189 billion as a result of increases in their operating tax rates (relative to their reported tax rates), while 655 companies had positive adjustments to NOPAT totaling $21 billion. Our database contains 32,270 non-operating tax adjustments for a total adjustment value of $1.2 trillion in losses from NOPAT and $325 billion in gains to NOPAT.

A large non-operating tax adjustment can sometimes be a contrary indicator, as in the case of UPS above. UPS had a large negative tax adjustment to NOPAT, but this was primarily because of large non-operating expenses, the removal of which resulted in a net positive adjustment to NOPAT. As a result, UPS still earns our Very Attractive rating.

General Motors (GM), on the other hand, has by far the largest negative tax adjustment to NOPAT, and it earns our Unattractive rating. Due to a variety of issues, GM actually had a total tax benefit (income) of nearly $35 billion in 2012. Removing the impact of major non-operating items, like a $27 billion goodwill impairment charge, gives GM a cash operating tax burden of $3.1 billion.

No company is going to have a $35 billion tax benefit long-term. Valuing GM based on that distorted tax number is a recipe for disaster. Due diligence in the footnotes is required to remove the distorting effects of non-operating items and reveal a company’s true tax burden.

Sam McBride contributed to this report

Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, or theme.

    4 replies to "Non-Operating Tax Adjustment – NOPAT Adjustment"

    • Dan


      I understand how Cash Operating Taxes are calculated as (NOPBT – the Change in Total Reserves) * Cash tax rate.
      But would you mind discussing a little more the formula you use to compute the cash tax rate?
      I have not been able to match your numbers.


    • Sam McBride

      Thanks for your question. Our cash tax rate calculation uses a company’s reported effective tax rate and then adjusts for any non-operating income/expense for which the company provides both a pre and post-tax amount. These non-recurring items can often generate tax benefits/liabilities at a much different level than normal operating income, so it’s important to account for them to calculate a company’s real recurring tax rate. Finally, we account for any unusual standalone tax benefits/charges (especially relevant this year and last with the impact of tax reform).

    • Rupert


      In an earlier document ( you spoke about cash tax rates, and you have also computed “normalized changes in deferred taxes”. It’s not clear to me whether the three year average is an average of cash tax rates for those three years, or an average of changes of deferred taxes across three years, assuming that is what is meant by normalized changes in deferred taxes.

    • Tamara Pesik

      Hi Rupert,
      Thanks for your question. The three year average is an average of cash tax rates for those three years, yes. We use a three-year normalized rate based on reported taxes adjusted for annual changes in reserves. Don’t hesitate to let us know if you have any follow up questions. You can also reach out to at any time.

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