Earnings persistence refers to whether or not the earnings of a company are expected to recur or not. The higher the persistence of earnings, the more sustainable the earnings. Earnings that are comprised of a high proportion of non-recurring items are considered to be unsustainable.
On this page, we discuss how to classify items as non-recurring what if meant by classification shifting. We also discuss how to analyze the degree of persistence using a regression model. An Excel spreadsheet example is available for download at the bottom of the page.
Earnings persistence definition
To analyze whether or not earnings are persistent, the first step is to classify items as non-recurring. This process is highly subjective. While shifting items between recurring and non-recurring will not impact total net income, it is a method used by management to make investors believe that the recurring part is higher than it actually is.
One commonly used method to overstate earnings is to mis-classify normal operating expenses as being expense from discontinued operations. Analysts should carefully analyze disclosures that reconcile pro-forma income with reported income. This way, investors can evaluate whether the items included as non-recurring are actually non-recurring. Another method to analyze whether or not earnings are of high quality, is to run a regression.
Earnings persistence formula
The following earnings persistence formula can be used to gauge the persistence of a company’s earnings
A higher value for the coefficient beta indicates that the company’s earnings are more persistent. Thus, the higher the beta, the better. The above formula is typically estimated using a simple ordinary least squares (OLS) regression.
Earnings persistence example
Let’s apply the above formula using a numerical example. The following table illustrates how we can use Excel to estimate earnings persistence. The higher the beta, the better
We discussed how to quantify the extent to which a company’s earnings are persistent. Another method to analyze persistence, is to look at accruals.
Download the Excel spreadsheet
Want to have an implementation in Excel? Download the Excel file: Earnings Persistence template