An analyst relies on a company’s earnings to gauge its health. However, an experienced one knows there are times when company earnings mask more than they disclose. Incidentally, there is a better way to build a more accurate picture of financial performance - Scrutinizing the income statement along with a rather obscure disclosure called ‘Accumulated Comprehensive Income’ – one that hides the vital ‘Other Comprehensive Income.’
What is Other Comprehensive Income?
Other Comprehensive Income, or OCI, found within ‘Accumulated Comprehensive Income’ is a more expansive view of net income. It is the amount of unrealized gains or losses adjusted directly against equity. OCI is undoubtedly a key component in understanding company earnings and balance sheet health, especially for large companies. Items included in OCI are:
- Unrealized gains/ losses on available for sale securities,
- Unrealized gains/ losses on cash flow hedge derivative instruments,
- Foreign currency translation adjustments,
- Adjustments related to pension or post-retirement benefit plans and
- Other than temporary impairments
It is acceptable to either report components of Other Comprehensive Income
- net of related tax effects, or
- before related tax effects with a single aggregate income tax expense or benefit that relates to all of the other comprehensive income items
If an item listed in OCI becomes a realized gain or loss, it is then reclassified out of OCI and into net income or loss. For E.g. - Sale of an investment security already recorded as an unrealized gain in OCI.
A closer look at Other Comprehensive Income for 2013-2015
In an effort to analyse the effect of OCI transactions on overall company performance, we studied the S&P 100 financial data for 3 years from 2013 to 2015 through our Data Consumption Platform (DCP). It was intriguing to find that for years 2014 and 2015, if the OCI transactions were to be actually realized, these could have potentially affected the Net Profits of the respective years by as much as 15%.
The trend of aggregate OCI over the past 3 years gives deeper insights.
Table 1: S&P 100 Companies showing Positive Vs Negative OCI for past 3 years
In 2013, majority of the S&P 100 companies (63 firms) had a positive OCI but in 2014, this dropped to 24 and then to just 15 in 2015. What does this suggest? Why the shift from positive OCI to negative?
1. Component Study of OCI for 2015
A closer look at OCI data for 2015 reveals that the OCI of most large firms is influenced by Foreign Exchange Transactions, Pension, Investments or Derivatives. In fact, over 70% of the S&P 100 companies have these 4 categories as major components of OCI.
Table 2: OCI Components for S&P 100 Companies for FY 2015
However, the biggest impact on OCI values is Foreign Exchange translations since 94 of the S&P 100 companies have this component and the Forex component which impacted 90% of the OCI value for 2015. Pension and Investments components too had a material impact on OCI values for 2015.
It is likely that the strong dollar in 2014 and 2015 has adversely affected the export earnings of most of the S&P 100 firms. A continuation of the trend in 2016 may further aggravate the situation.
2. Effect of Positive OCI vs Negative OCI
At an aggregate level, the OCI for the S&P 100 companies was almost unchanged at a negative $ 107 bn in FY 2015 when compared to FY 2014’s OCI value of a negative $106 bn.
Table 3A: S&P 100 Companies having positive versus negative OCI as against the Net Profit for past 3 years
However, when seen in conjunction with the Net Profits of the Companies, a different picture emerges. The Net Profits of companies with positive OCI, on an aggregate basis, would have been positively affected by over 15% had the OCI been realized. Similarly, the Net Profits of companies with negative OCI, on an aggregate basis, would have been adversely affected by 20%.
Another aspect to the OCI is its volatility. In 2013, the total OCI was positive and this turned negative in 2014. Hence the change in OCI between 2013 and 2014 had a potential negative impact of a hefty 27% on the FY 2014 Net Profits (Table 3B).
Table 3B: S&P 100 Companies' Change in OCI as against the Net Profit for past 3 years
In FY 2015, the OCI remained stable on an aggregate basis and thus the change in OCI between 2014 and 2015 did not ‘rock the boat’.
The OCI values for the S&P 100 firms for the years 2013, 2014 and 2015 can be accessed via this link here.
The OCI values and the value of its constituent components for the S&P 100 firms for FY 2015 is available via this link here.
3. Companies with OCI substantial enough to affect Net Profits if reclassified
Finally, we shortlisted companies whose OCI comprises more than 30% of that year’s Net Profits.
Table 4: S&P 100 Companies where OCI comprises more than 30% of Net Profit for FY 2014 & 2015
The 15 companies listed in the table along with their OCI component values for FY 2015 and FY 2014 could potentially see big fluctuations in their shareholder equity value for FY 2016.