NOPAT Adjustment: Foreign Exchange Loss

The real earnings season is nearly over. For the past month and a half, our analysts have diligently gone through over 3,000 annual reports, Form 10-K’s, to make adjustments from GAAP numbers to economic earnings. This report features an interesting non-operating item we’ve discovered in numerous filings.

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 perform unrivalled due diligence on over 3,000 10-Ks every year.

Foreign currency exchange losses are unusual charges that often don’t appear directly on the income statement because they are bundled in other line items. Without careful footnotes research, investors would never know that these currency devaluation charges distort GAAP numbers by lowering operating earnings. In 2013, the devaluation of the Venezuelan Bolivar had a negative impact on a large number of companies.

The Bolivar Fuerte was adopted as the national currency of Venezuela in 2008. Companies operating in Venezuela must obtain government approval to exchange Bolivars to US Dollars at the official exchange rate. Effective January 1, 2011, the Venezuelan government established a fixed rate of 4.30 per dollar. Again, effective February 13, 2013 the currency was further devalued to a rate of 6.30 per dollar. This change caused many companies to take large charges on the remeasurement of their Venezuelan operations for their 2013 fiscal years. Such a charge is a one-time, non-operating expense and is not indicative of the operations of the company.

Our models remove this distortion to reveal a company’s recurring, core-operating profitability or NOPAT.

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