Background: For Joel Greenblatt's "Magic Formula," he defines earnings yield as EBIT/. Further, he defines including preferred equity + net interest bearing debt.
I'm looking at a potential investment in Socket Mobile (SCKT). In 2015, Sckt had EBIT of $2.1M on an EV of $3.7M for an Earnings Yield of 58%. In 2016, however, Sckt recognized a relatively substantial amount of deferred tax assets ($9.6M), for what appears to's, considering its equity value prior to the recognition. Thus in 2016 on EBIT of $2.6M on an EV (including the deferred tax asset) $15.6M, Earnings Yield was a dismal 1.6%.
My question is how do you treat a deferred tax asset in calculating Enterprise Value, and more importantly, in calculating the Earnings Yield for 2016 and subsequent years??
I understand Deferred Tax Assets - could - be used in future years to reduce taxes. And while there is a potential benefit for a takeover acquirer, and thus it should be included in the total enterprise value for takeover purposes, it seems, to me, to skew the Earnings Yield of the enterprise since it is non-core operating asset that falls to equity.
Thus, if you assume away the Deferred Tax Asset for purposes of calculating the Earnings Yield, EBIT remains $2.6M and EV becomes $6M and Earnings Yield becomes 43%.
It seems to me that this is a more appropriate recognition of the 2016 Earnings Yield. Why or why doesn't this though hold up??
Further, if this method of assuming away the Deferred Tax Asset from the Equity Value in the calculation of Enterprise Value is used in a single year, how is it used in subsequent years?? The DTA would be reduced each year (assuming the company remains profitable) and the increase in Retained Earnings would replace the reduction in the DTA over the long-term. Is this correct thinking??