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Accounting Watch: Important to compare accounting standards when comparing company valuations - Looking under Tata Motors' hood

11/7/2014

 
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Accounting is an allocation exercise.  Cash is real.
India's Tata Motors highlights importance of comparing accounting standards when comparing companies.  

Tata accounts for research and development costs differently than peers in a way which boosts profit in the near term.   If comparing P/E ratios, this actually makes Tata more expensive than initially appears.

Tata's R&D program, at 6% of sales, is higher than 4%-5% global car makers typically spend on new products and designs.

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Indian accounting standards give Tata discretion in accounting for R&D spending. Company can treat as immediate expense, which reduces income. Or can capitalize R&D spending, recognizing the expense over longer period of time.  Tata will have to amortize R&D spending once cars under development hit market. This will reduce future profits.

Tata capitalized roughly 80% of R&D activity fiscal year 2012/13. 

Indian SUV-maker Mahindra & Mahindra capitalized 44% of R&D.

American and Japanese car makers expense all R&D spending, as local accounting rules require. 

German auto makers, who report under international accounting standards, can capitalize R&D, though this has averaged only a third at BMW last 5 years.

Tata may need more R&D than BMW and Mahindra. 

Tata says has followed this practice for years, meaning it isn't changing course.

Net effect of Tata's R&D accounting is to bolster the bottom line. If all R&D spending were expensed, Tata's net profit would fall by 2/3rds, estimates Bernstein Research. Damlier's earnings would decreases by -10%. BMW's earnings would be boosted +1% since it amortizes older R&D spending and bears expense on income statement.

Adjusting for R&D this way, Tata's P/E valuation ratio increases from 9.6x to 28x earnings. Valuations at Daimler and BMW come in at 11.3x and 10.1x, after the same adjustments.

Source: http://online.wsj.com/news/articles/SB10001424052702303789604579199210852043816

CKB Solutions is all about real solutions for the real world.  To learn how we can help your business, contact Greg Kovacic in Hong Kong.


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    Author

    Greg Kovacic is a Director with CKB Solutions in Hong Kong. He advises senior executives and entrepreneurs on strategy, corporate finance, operations and marketing with a focus on crafting real solutions for the real world.  
    You can contact Greg at: greg@ckbsolutions.com

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