Sorting The Signal From The Noise In This Telecom Giant’s 10-K

Our latest featured stock is a telecom giant with confusing and inconsistent accounting earnings. We pulled this highlight from last week’s research of 364 10-K filings.

Analyst Jacob McDonough found several unusual items in the footnotes of Verizon’s (VZ) 2018 10-K.

Verizon’s GAAP net income declined by nearly 50% in 2018, but Figure 1 shows that its economic earnings, the true cash flows of the business, grew by 10%.

Figure 1: GAAP vs. Economic Earnings for VZ Since 2014

Sources: New Constructs, LLC and company filings.

In 2017, VZ’s GAAP net income was overstated due to a $16.8 billion (13% of revenue) benefit from tax reform. After the passage of the tax law, we listed VZ as one of our “Tax Reform Winners” due to its large amount of deferred tax liabilities.

Meanwhile, in 2018, GAAP net income understated VZ’s profitability due to two major non-recurring expenses:

  1. $3.4 billion (3% of revenue) in restructuring and acquisition-related costs
  2. $4.6 billion (4% of revenue) write-down to the goodwill in its Oath (AOL and Yahoo) segment

While our adjustments make VZ’s income statement look better, they make the balance sheet look worse. We add the Oath write-down back to VZ’s invested capital in order to hold the company responsible for the capital invested in those acquisitions. We also add the company’s $21.1 billion (9% of reported net assets) in off-balance sheet debt, which is up from $16.8 billion in 2017. These adjustments show that while VZ’s reported net assets increased by just 1% in 2018, its invested capital increased by 5%.

In addition, the large write-down raises a red flag about the company’s capital allocation. VZ’s rising economic earnings led our rating system to upgrade the stock to Attractive after we analyzed its 10-K, but investors should still approach this stock with caution until management demonstrates that it can avoid more wasteful acquisitions.

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Disclosure: David Trainer, Jacob McDonough, and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme.

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