I am amazed that so many Wall Street pundits and investors alike still love AutoZone Inc. (NYSE:AZO) and consider the stock to be cheaply priced. They always point to AZO's consistent double-digit earnings growth as the reason for investing in the stock, even if those same EPS figures are manipulated by leveraged stock buybacks and inventory classifications. I must admit that the longs in this stock have done very well over the years, and I have been utterly astounded at how well management has financially engineered this company and its underlying stock price. Management utilized as much leverage as they could squeeze out of bankers and the company's suppliers for the sole purpose of buying back AutoZone shares. This has caused the stock to rise over 500% during the past 7 years and has made management rich in the process, as they were able to cash out their employee stock options worth hundreds of millions of dollars during this period. The management team owns less than 1% of all outstanding shares, but continues to authorize these huge buybacks. Management is willing to use other people's money to buy the stock, but not their own money.

How much leverage has AutoZone utilized? Currently, the company has $5 billion in long-term debt that it was able to borrow from bankers and institutional investors in its debt offerings. It squeezed another $4 billion from its suppliers, which is the amount currently owed. Amazingly, AutoZone only has $3.6 billion in inventory right now, and even if the company sold every single item in its stores, it still would not have enough money to pay off their suppliers, let alone the bankers and debtholders. That is why even though Wall Street currently values this company at $22 billion, it actually has a negative $2 billion tangible book value. What this means is that if one day this company is forced into bankruptcy protection filing and is liquidated, it owes $2 billion more than all the assets it has to sell. As AutoZone continues to squeeze suppliers and borrow more money for buybacks, that deficit will continue to grow even larger

For investors who love to dig through the 10-Q filings to uncover potential manipulation on earnings by management, here is one consistent footnote in AZO's 10-Q that allows the company to report higher income each quarter from its use of LIFO as an inventory method.

Note F - Merchandise Inventories

Merchandise inventories are stated at the lower of cost or market. Merchandise inventories include related purchasing, storage, and handling costs. Inventory cost has been determined using the last-in, first-out ("LIFO") method for domestic inventories and the first-in, first-out method for Mexico and Brazil inventories. Due to price deflation on the Company's merchandise purchases, the Company has exhausted its LIFO reserve balance. The Company's policy is not to write up inventory in excess of replacement cost, which is based on average cost. The difference between LIFO cost and replacement cost, which will be reduced upon experiencing price inflation on the Company's merchandise purchases, was $349.4 million at May 7, 2016 and $332.6 million at August 29, 2015.

Since profits reported are greatly affected by what figure a company reports for Cost of Goods Sold, it is important to understand how a company's choice of accounting for inventory can affect its earnings. The higher the ending inventory figure, the lower the Cost of Goods Sold will be and the higher the profit reported will be.

LIFO income statement in a falling price environment

The LIFO method will raise reported margins. Most recent goods are the least expensive, and LIFO will calculate lower COGS and, thus, a higher gross margin. To better understand this concept, I recommend reading FIFO versus LIFO accounting.

Under US GAAP, concerned that LIFO liquidation profits can distort users' predictions regarding future profits and companies can manipulate profits by intentionally liquidating LIFO layers, the SEC mandates that companies disclose LIFO liquidation profits in footnotes and Congress is pushing to eliminate LIFO accounting all together.

The AZO footnote F is mandated by the SEC, but since most investors don't read through SEC filings, let alone understand the footnote and its meaning, the company continues to reap the benefits of reporting what are, in my opinion, financially engineered EPS figures. During the first 3 reporting quarters of this year alone, AZO was able to report almost $17 million more in earnings (or $.55 EPS) from its LIFO liquidation profits. This is calculated by taking the $349.4 million minus $332.6 million from the footnote F. The footnote itself should have more clearly explained that profits were inflated because of LIFO liquidation, but not all companies and their auditors comply with this SEC mandate.

Based on a careful examination of the underlying financials of AutoZone Inc., I would take a contrarian point of view on AZO and say that the company's real earnings growth rate is far less than what the current reported EPS figures seem to portray. I also believe the leverage used by management for stock buybacks, which has reduce outstanding shares and increased those EPS figures, is actually setting the stock price up to inevitably implode some day in the future under a mountain of debt. I believe the stock is currently overvalued and over-owned by institutional shareholders, and would consider the stock a potential short candidate longer term, as I question the sustainability of this financial engineering.