This question pertains to many classic financial calculations -- ROE, average shareholder equity, DuPont models, debt to equity ratio, etc. These formulae are fairly easy to interpret and apply for the average company in reasonable health. But generally, how do you deal with such oddball situations as negative equity -- now or in one or two previous periods. e.g. a profitable company should have great ratios, but what if dividends strip all equity on a regular basis, or even take equity negative. Company is still a healthy cash machine. How do these formulae play out then?
e.g. equity at Jan 1 is $2mm; equity at Dec 31 is minus $0.5mm, due to profits less paid dividends being more than $2mm negative, then what is "average shareholder equity"? Or what if equity went negative due to a minority interest buyout at a premium over equity book value, etc. Standard formulae do not apply that easily.
What is the debt to equity ratio if debt is $1mm and the equity is minus $0.25mm?
Similarly for historical losses, -- how do you measure a company's past profitability ratios if they had, say, 5 profit years and 2 loss years -- netting off does not necessarily produce a realistic answer for valuation purposes.
The answers could be long -- but generally, how do you deal with such situations? Does one just assume that standard financial calcs no longer apply? I always wondered if finance students ask such questions in a high level finance class.
