As we’ve discussed before, it is much easier to predict a company’s operating earnings than it is its net income, due to changes in debt levels, interest rates, non-operating earnings, and one-time tax items which all affect the latter but not the former. When attempting to value a company using these estimates of operating earnings, however, care must be taken to avoid blanketing each company with the same general tax rate.
Since most North American companies face a tax rate of around 35%, it is tempting to apply this estimate blindly when running a back-of-the-envelope valuation
of a company under consideration. However, due to certain credits, tax treaties, and subsidiary jurisdictions, companies can have very
different tax rates, which can wildly throw off a valuation.
Consider Dorel (DII.B
), a diversified manufacturer of juvenile products and furniture. Because its foreign subsidiaries operate in low
-tax jurisdictions, its effective tax rate is only around 15%! Dorel’s 2008 income before tax was $132 million, but thanks to its low tax rate this is equivalent to income before tax of $170 million (for a company with a 35% tax rate to have the same after tax earnings as Dorel)…a massive difference!
For a more detailed discussion of Dorel as a possible value investment, see this article