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Not All Earnings Growth Are The Same

Ser Jing - There's More Than Meets the Eye With Steady Dividends (pic) 

Yoma Strategic Holdings (SGX: Z59) is a company that’s flying high. Over the past 12 months, as seen from the chart below, its shares have gained 126%, soundly trouncing the market, as represented by the Straits Times Index’s (SGX: ^STI) 7.9% return.

not all earnings growth graph

Source: Yahoo Finance

The company’s main business interests lie with real estate, agricultural activities, and automobile dealership in Myanmar. In addition, it also has real estate-related operations in China.

Yoma has had stupendous cumulative growth in its reported earnings for its last two completed financial years. The company earned S$2.8m for its financial year ended March 2011 and by the financial year ended March 2013, its profits have jumped by 416% to S$14.4m.

That strong earnings growth is a likely reason for the company’s strong share price appreciation. Another possible reason for Yoma’s outperformance in the market could be due to its links with Myanmar, a country that’s only just opened her doors to foreign investment in recent years.

With a population size that was last tabled at 48m in 2011, there’s plenty of hope that Myanmar’s emerging market can provide growth for years to come, although there’ll likely be bumps and obstacles along the way.

In any case, market participants in the SGX are certainly having high hopes for Yoma. The company trades at a lofty trailing Price-Earnings ratio of 63.4 at its current share price of S$0.92 – even as the market’s average PE is only around 13.2 – signifying much rosier expectations for Yoma as compared to the rest of the market.

On first glance, that PE-ratio might seem justified given Yoma’s prospects in Myanmar and the fact that its profit of S$14.4m for the recently completed financial year ended March 2013 was 139% higher than the previous year’s.

But, on closer inspection, a huge bulk of Yoma’s profit for the financial year ended March 2013 is actually not from its core operations. The profit-figure of S$14.4m actually contains income of S$9.05m that stems from negative goodwill following Yoma’s transfer of assets, from a wholly-owned subsidiary, into its own financial statements.

Negative goodwill arises when the transfer of assets occurs at a price that’s less than the assets’ appraised value, allowing the party that eventually houses the transferred-assets (in this case, Yoma), to book a ‘profit’.

While that looks good on paper, such profits are certainly not part of Yoma’s core operations and can’t possibly happen too frequently. If it were stripped away, Yoma’s operating profit would only be S$5.2m, a decline from the previous year’s profit of S$6.14m.

In Yoma’s earnings-release, it stated that its net operating profit, after stripping away the portion arising from negative goodwill, stands at S$12.1m. But, that’s a figure that includes stock-based compensation totalling S$6.9m. Stock-based compensations are actually normal expenses as they form part of employees’ ‘salary’, so to speak.

So, a truer picture of Yoma’s profits for the financial year ended 31 March 2013 should be S$5.2m and not S$12.1m or S$14.4m.

Foolish Bottom Line

Yoma, at its current price, carries with it high expectations for future growth as exemplified by a lofty PE multiple. And, it’s true that Yoma might yet go on to benefit tremendously from Myanmar’s economic growth and reward shareholders greatly in the process.

But, at high PE multiples, it becomes even more important for investors to drill deeper into a company’s earnings reports to find out the true source of a company’s growth.

Is the earnings growth coming from the company’s core business activities, or is the growth actually coming from non-recurring, one-off items?

These are questions investors have to ask themselves because ultimately, the results can be ugly when high-expected-growth in shares fails to materialise.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.