An index that captures the deviation between actual income and trend income. The higher the index, the more unstable (less stable) a firm’s profitability is. A firm with an unstable earnings trend is exposed to a higher degree of risk than a firm with a stable trend. The instability index is calculated using the following formula:
Where: y is the reported net income and yT is the trend income for period T. The trend income is usually computed using a trend equation such as this:
yT= a + b (t)
Where: a is the dollar intercept, b is the slope of trend line, and t is the time period.
Other measures of earnings stability or instability include:
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