1) Analyst should recognize whether the equity method is appropriate to use or not i.e. a company may prefer to use equity method to include associate income as equity income even when it has no significant influence on the investee simply to enhance its profits.
2) An analyst should recognize whether a company which has control over the investee use equity method to enhance its financial performance, because under equity method:
· No asset or liability of the investee is required to be reported on the investor’s balance sheet. This lowers debt ratio.
· Associate income is included in the investor net income but associate revenue is not included. This leads to overstated Net margin ratios.
3) Analyst must also determine the quality of the Equity method Earnings i.e. proportionate share of the investee’s income is included as Investor’s income although no cash is actually received.