When we looked at Spark Networks’ glowing P/E, we noticed that it was due in large part to a huge tax benefit due to past operating losses. Since this tax benefit would not occur in the future, the company’s current net income had to be discounted by a tax rate in order to determine the company’s true earning power going forward. For Gildan Activewear (GIL), we see similarly suspicious earnings after taxes:
Clearly, this is an unusual situation. So should we chop net income by a normal tax rate in order to determine a sustainable income going forward? Not without a closer look.
Further investigation reveals that the company’s “low overall consolidated tax rate reflects the operating structure of the company under which all of our sales, marketing and manufacturing functions are carried out at low tax rate jurisdictions in the Caribbean basin and Central America, with only corporate head office functions based in Canada…As far as our tax rate, including our retail business, we are looking at an overall consolidated tax rate…of around 6%…And we are fully confident of sustaining our low tax rate for the period on an ongoing basis” (source: 2008 Q4 conference call)
By maintaining much of its operations in low tax jurisdictions, Gilden management has found a great way to add value for shareholders. Assuming a 35% tax rate, this corporate structure has increased the value of the company by nearly 50%, minus any extra costs associated with operating in those regions!