For years, the ultimate driver for long-term stock returns, be it capital growth or dividend income, lies in their earnings growth. 

As investors, there are two reasons to read the income statement of a stock. First, it is to ensure that the stock had delivered consistent earnings growth before investing. Second, once we have invested in the stock, we want to ensure that the stock continues to deliver earnings growth over the long-term. So once again, the key word is earnings growth. 

When reading an income statement, we would come across: 

Source: Scientex Bhd Annual Report 2024

There are three terms: 

1. Profit for the Year (Profits After Tax or PAT)
2. Profit for the Year attributable to Owners of the Company (Shareholders’ Earnings)
3. Profit for the Year attributable to Non-Controlling Interests (NCI). 

Their equation is as follows: 

PAT = Shareholders’ Earnings + NCI’s Profits

Here, I’ll explain what they are and how we can use them as investors. To do that, I’ll start with a simple illustration as follows: 

Case Study: A Bhd

Let’s say we have A Bhd, a public listed holding company. 

A Bhd has 2 subsidiaries namely A1 Sdn Bhd (A1) and A2 Sdn Bhd (A2). 

A Bhd owns 100% shareholdings in A1. 

A Bhd owns 80% shareholdings in A2. The remaining 20% shareholdings are now owned by the business partners of A Bhd. These business partners are known as “non-controlling interests” of A Bhd as they don’t own shares in A Bhd. 

A Bhd’s corporate structure is as follows:

Their Profitability

Let’s assume that A1 Sdn Bhd and A2 Sdn Bhd have the following income statements: 

As a shareholder of A Bhd, we are entitled to 100% of A1’s profits and 80% of A2’s profits. Such would equate to a total profit of RM 28 million. Technically, we are entitled to the following:

But, today’s financial statements are not prepared the way as illustrated above. 

Why? 

This is because the work to do so is tedious. 

Take a look at Scientex Bhd. It is a public listed company that has subsidiaries, both directly and indirectly owned, associate companies and joint venture companies. Some of these subsidiaries are 100% owned by Scientex Bhd. Some are not. Imagine accountants needing to compute a % of revenue, cost, profits, assets, liabilities, and as well as its cash flows based on Scientex Bhd’s shareholdings for each and every single company. It is not impossible but highly impractical as it is time consuming and cost ineffective. Accounting and financial reporting is also a cost!

Source: Scientex Bhd Annual Report 2024

How Financial Statements are Prepared?

Instead of %, all financial statements are prepared on an as if 100% basis. 

For A Bhd, its financial statement is “first” prepared as if it owns 100% shareholdings in A2. That is Step 1. As such, A Bhd’s profit for the year works out to be RM 30 million. 

Next, we have Step 2, which involves the exclusion of NCI’s profits from profit for the year. It is presented as follows: 

When to Use “Profit for the Year”?

As an investor, I use “profit for the year” to calculate net profit margin (NPM). In A Bhd’s case, I’ll calculate its NPM by dividing “profit for the year” with revenue. Thus, its NPM is 15%. 

NPM = Profit for the Year / Revenue x 100%

When to Use “Shareholders’ Earnings”?

There are 2 ways that I use “shareholders’ earnings”. 

First, I would calculate a stock’s earnings per share (EPS) with shareholders’ earnings. Then, I’ll value the stock by calculating its current P/E Ratio. 

Second, I would calculate the stock’s EPS over the past 11 years. Of which, I would calculate its compound annual growth rate (CAGR) to find out its earnings growth rate. The higher its CAGR, the more attractive a stock is for long-term investment. 

Conclusion: 

Here are the key takeaways for this note: 

1. Use “profit for the year” to calculate net profit margin (NPM). 
2. Do not bother with “profits attributable to NCI” as this is not earnings belonging to investors. 
3. Use “shareholders’ earnings” as a basis for valuation as such earnings belong to us.

For those of you, who intend to learn how to build a Dividend-based Portfolio or a Growth-based Portfolio, once again, it is a matter of suitability between the educator and yourself. Below would be the links to free webinars so that you can check us out and assess if we’re the right fit for you personally. 

Dividend Investing:
Free Webinar: How to Build a Stock Portfolio that Pay Increasing Dividends?

Growth Investing:
Online Training: Case Study of 1 Actual Stock that I had Invested in and Why It Doesn’t Take High Risk to Generate High Returns in the Stock Market?