The Real Earnings Season Starts Now: Time To Read Filings & Footnotes

Quarterly earnings season may be winding down, but the real earnings season – annual 10-K filing season – is ramping up. Investors ignoring filings, footnotes, and the MD&A are in the Danger Zone.

Why Footnotes Matter – Analysts & GAAP Earnings Are Off by ~20% On Average

Since 2005, we’ve reported how traditional earnings measures are unreliable due to accounting loopholes that allow companies to manage earnings.

A new paper from Harvard Business School & MIT Sloan proves GAAP and Wall Street earnings are off by nearly 20% on average[1]. The paper is titled Core Earnings: New Data and Evidence and has been selected for publication in The Journal of Financial Economics.

The only way to overcome the flaws in GAAP net income (and other profit metrics from legacy providers) is through rigorous analysis of company filings, especially the footnotes and MD&A[2].

Below, we provide an example of a new tool for earnings management and highlight two companies with highly misleading GAAP net income.

New Loophole: Bitcoin Accounting Treatment

Bitcoin investing is the latest accounting loophole used to manage earnings.  

MicroStrategy (MSTR: $928/share) provides an example of how reported GAAP net income understates true profits due to Bitcoin losses rather than any change in the firm’s core operations. In 2020, MicroStrategy recorded a $71 million impairment charge (nearly 2x the firm’s 2020 Core Earnings) related to the firm’s Bitcoin assets. More details here.

Tesla’s (TSLA: $787/share) recent purchase of Bitcoin could create a similar scenario for potential earnings management. While Tesla’s Bitcoin purchase doesn’t require any adjustment yet, without being aware of all unusual items, you’ll never know when an adjustment will materially impact a firm’s true fundamentals, and in turn, its valuation.

Going forward, we will remove any gains/losses firms realize when they sell Bitcoin from our calculations of profits, as these gains/losses represent non-operating income/losses. Without this diligence, investors could make misinformed investment decisions.

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Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.

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