Using ‘economic accounting’ helps Deutsche to double the returns of dividend benchmarks

Analysts at Deutsche Bank are calculating and then applying companies’ economic earnings to the discipline of dividend investing – with some startling results often quite contrary to traditional equity income strategies.

The German banks’ analysis of 760 non-financial stocks worldwide found that a company’s financial health could look significantly different when taking an economic approach to accounting, rather than relying on accepted accounting methods behind companies’ reports to investors.

There are various differences between CROCI’s earnings analysis, and production of reported, audited numbers that most fund managers rely, and buy, on.

Work using the wrong earnings assumptions, and many other important ratios used to assess investability will be skewed, says Francesco Curto, head of the CROCI Investment Strategy and Valuation Group.

He says reported numbers are based on methods “whose objective is to justify the legal requirements of an accounting system”.

Significantly, economic earnings take into account the effect that real-world economic variables – such as inflation – have on companies’ earnings. The figure produced is a ‘real earnings’ number, and sometimes worlds away from reported numbers investors base their trading, forecasts and ratios on.

In the case of Exxon in 1982, for example, healthy reported net income of $4.2bn under reported accounting became a $296m loss after the company adjusted these results for general inflation.

Deutsche’s CROCI (Cash Return on Capital Invested) team makes five adjustments (inflation, financial leverage, economic life, intangibles and goodwill) to move from an accounting to an economic basis.

They employ relevant local currencies for plant, machinery and earnings of multi-jurisdictional companies; they apply discrete asset-specific depreciation schedules where necessary; and they bring back on-balance sheets items that companies have placed off-balance sheet.

Francesco Curto (pictured), Head of the CROCI Investment Strategy and Valuation Group, says dividend investing “thinking of an equity like a bond” – still makes sense, not least because the low develop- world growth environment widely expected could cap real earnings growth.
But different analysis will produce to identify ‘dividend stocks’ will result in very different sector preferences, for example.


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