normalized earnings

For cyclical firms, the easiest solution to the problem of volatile earnings over time and negative earnings in the base period is to normalize earnings. When normalizing earnings for a firm with negative earnings, we are simply trying to answer the question: What would this firm earn in a normal year? Implicit in this statement is the assumption that the current year is not a normal year and that earnings will recover quickly to normal levels. This approach, therefore, is most appropriate for cyclical firms in mature businesses. - Prof Aswath Damodaran

How this can be done (by Jae Jun)

ROE method:

1. Get the past 3 years and TTM ROE ratio
2. Take the average
3. Multiple the average ROE to the latest shareholder’s equity figure from the balance sheet to get the normalized net income
4. Divide by shares outstanding to get normalized earnings

Profit margin method:

1. Get the last three year net margin and TTM
2. Take the average
3. Mutiply the average net margin to the TTM revenue to get normalized net income
4. Divide by shares outstanding to get normalized earnings