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accumulated tax losses
Although no company enjoys being in a loss-making situation, one advantage of having a bad spell with
red ink flowing over several years is the corresponding accumulation of those losses which can be
used to reduce the tax charge in the first few years a profit is chalked up.
For instance, let's look at company Slow Start, that we assume operates in a country where the corporate
tax rate is 30%. Slow Start loses $30m in its first year of operations and $5m in its second. In its third
year it makes $10m and in its fourth $200m. The bad years add up to accumulated losses of $35m. These
losses are looked upon by the pleasant gentlemen in that country's inland revenue department as
accumulated tax credits. These credits fully offset the profit of the third year so no tax is
payable. $10m worth of credits is exhausted in offsetting the profit of Year 3, leaving $25m in unutilised.
In the fourth, bonanza, year when Slow Start makes a pre-tax profit of $200m, the tax department will offset
that by the remaining tax credits, leaving $175m to be hit by the 30% tax charge. For that year the
company's taxes come to $52.5m (30% of $175m, not 30% of $200m).
Note that because of the gradual utilisation of the accumulated tax credits, the effective tax rate of
Slow Start in Year 3 is 0%, and in Year 4 it is 26.25% (that is 100% x 52.5m/200m). When analysing companies
for potential investment worthiness it is important to look out for peculiarly low effective tax
rates and to determine if and when accumulated tax losses run out. Usually when they are fully exhausted,
a company's EPS will take a battering. (See taxation.)
bonus issue
If a company has sufficient shareholders' funds built up from its retained earnings over the years, its
board may choose to reward shareholders by issuing new shares. If a 1-for-2 bonus issue is declared, then a
shareholder with 20,000 shares will end up with 10,000 more. Generally speaking though nothing has
intrinsically changed with the company. Therefore, logically speaking the company's market capitalisation
should not change. This means that the new equity base including the 50% increase in the number of shares
should see a per share price adjustment. If previously the shares had been trading at $3, after the bonus
issue they should trade at {2/(1+2)} x $3 = $2.
As a general rule the expected adjustment in share price for an X-for-Y bonus issue, where X bonus shares
are given out for every Y old shares held is:
Adjusted share price = {Y/(X+Y)} x the old price
In practice however because of the greater liquidity arising from more shares in the hands of
investors and also because many companies prefer to maintain or even increase the dividend paid out on
each share, there is usually a price adjustment to a level above the theoretically calculated price.
Gray's Deadly Sin 2
Don't be Ignorant. (Do your homework and gather sufficient information. Wisdom lies in knowing how much that
is. Study the strategies of Graham, Buffett, Lynch, Fisher, Gray and
other savvy investors and be humble enough to learn.)
NB.
Underlined terms in definitions refer to other entries in the book.
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[Source:
Your A-Z Guide to the Stock Market - and all you need to know about
Capital Terms; published by Times Books International. © 1997 Rajen
Devadason]
