How do you calculate normalised earnings?

Start by looking at historical margins over a full business cycle, typically five to ten years. Then adjust for one-off items, structural cost changes and any trends in the margin. The result is an estimate of what the company should be able to earn under normal conditions going forward.

Is normalised earnings the same as forward P/E?

Not quite. Forward P/E is based on analyst forecasts for next year. Normalised earnings is based on an independent estimate of sustainable earnings, adjusted for the cycle and structural factors. It is the analyst's own estimate, not market consensus.

Why not just use reported earnings?

Reported earnings reflect a single quarter or year, and can be affected by one-off items, accounting choices and cyclical factors. The goal is to understand what the company actually earns in its ongoing operations, not what the numbers say in a specific year.

How do you handle companies without a stable track record?

With caution. Companies with a short history or highly volatile margins are harder to normalise. In such cases it is appropriate to be more conservative in assumptions and require a larger margin of safety to compensate for the uncertainty.

Glossary

Normalised earnings

What a company can earn under normal conditions, stripped of temporary factors. The foundation for assessing sustainable profitability and fair value.

What it is

Earnings beyond any single quarter

Normalised earnings is an estimate of the earnings a company can generate in a normal year, cleansed of temporary factors such as one-off items, cyclical peaks and troughs, currency movements and extraordinary events. Reported earnings can mislead. A year of unusually high profitability may tempt overvaluation. A weak year can push the share price unnecessarily low. Normalised earnings provide a more stable picture of what the company actually deserves to earn.

Beyond one-off items: Capital gains, restructuring charges and write-downs appear in the report but do not belong to ongoing operations. These are stripped out in normalisation.
Cycle adjustment: Cyclical companies earn more at the peak and less in the trough. Normalisation means finding a sustainable midpoint rather than projecting peak margins.
Quality of earnings: How the profit is generated matters. Reported earnings can be manipulated. Cash flow is harder to hide. Companies where profit is real and paid out as free cash flow are preferable.

In practice

The starting point for valuation

Before setting a fair value for a company, a view on normalised earnings is needed. That is the foundation the valuation is built on. It is about separating what a company actually earns from what happens to be in the quarterly report. The market may have a completely different view, and that is exactly where the investment opportunity arises.

“Returns should come from the company's earnings, not from the next buyer's optimism.”

Amos Fonder

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Common questions about normalised earnings

Related concepts

Glossary

Active Fund Management

A management strategy where the portfolio manager actively selects stocks, unlike a passive index fund that mechanically tracks a benchmark. The goal is to generate returns above the index.

Net asset value

The value of a company's underlying assets minus its liabilities. Primarily used when analysing investment companies and asset-heavy businesses.

Fundamental Analysis

The method of analysing a company's financials, business model, and competitive position to assess its true value. The foundation of conviction-based active management.

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