Investors who possess basic knowledge can evaluate companies based on various key indicators. This allows them to decide whether to buy, hold or sell shares in certain companies independently of the opinions of analysts. The price/earnings ratio, dividend yield, market capitalization and return on equity are some of the most important key figures when it comes to evaluating shares. The degree of internal financing, liquidity ratios, cash flow margins and the EBIT margin, amongst other things, are key indicators in the analysis of companies. More on the main key figures can be found in the article entitled “Shares – the five most important key figures”.

EBIT: understanding the operating result

EBIT stands for earnings before interest and taxes and shows us how much profit a company has generated over a certain period (e.g. a year). All expenses and income – except for the interest and taxes mentioned – are included in the result. This should provide a basis on which the profit of various companies can be compared easily.

Extraordinary items affect profit

The EBIT does not take account of these so-called extraordinary items. Extraordinary items include, for example, the acquisition of other companies, restructuring measures or external factors, such as natural disasters or rising raw material prices. Put simply, all one-off, exceptional expenses and income come under extraordinary items. Such items can have either a positive or negative effect on the balance sheet and therefore profit too – for example, if a company sells a piece of land it owns for a lucrative price, the profit increases. However, if the inventories of a paper factory fall victim to a flood, for example, profit falls – unless the inventories were fully insured of course.

From adjustment to accounting trick

What actually appears very logical thus far has increasingly been used as a trick in recent years. Companies declare depreciation or renovations, for example, as extraordinary items to distort EBIT in they way they want. Not all companies do this of course. However, when analysing balance sheets, if you come across a company posting particularly high income or losses without identifiable, proven grounds, you should look more closely at exactly what lies behind the profit or loss. Is it really an extraordinary item or just a ploy?

This also applies to the economy.

It is not just in the private sector that extraordinary items are increasingly being used: they also concern nations and national banks or currency regions, for example, when economic growth forecasts are being made. Tax reforms, rises or falls in immigration and emigration or even climatic factors can play a part in the economy. A particularly mild year can affect a nation’s entire construction industry. If, for example, there are spring-like temperatures at the end of February, more building will take place than if there was still snow and frost in May. This means the entire construction industry would benefit in the first quarter of the year which in turn has an impact on economic performance and so too a nation’s forecasts, trends and monetary policy.

Extraordinary items can therefore affect the figures of both a company and an economy. Becoming familiar with and understanding them helps investors to better assess results and forecasts and to gain a more accurate insight into whether an investment is worthwhile or not. Anyone planning to do their own analysis of shares and companies should familiarize themselves with the basic principles of evaluating shares and balance sheets.