No industry is free from the inconsistent rules of GAAP accounting that create extensive distortions from economic reality. In this issue, we highlight a chemicals company, a payroll servicer, and a diversified industrial conglomerate. Everything from net earnings to total assets is calculated in ways that seem almost arbitrary under Generally Accepted Accounting Principles.
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Stock-based compensation (SBC) is an accounting headache. Just last year, PwC published a 250+ page report to help its clients navigate its intricacies.
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In mid-1998, Coca-Cola’s (KO:USA) stock price traded at a high of about $88 per share. Almost eight years later, the firm’s stock price stood at half that mark: $44. Did the company lose their incredible competitive advantages?
Around the same time, an incredible stock price run was taking shape. A major discount retailer watched as its stock price soared more than tenfold from 1996 to 2000. It wasn’t Wal-Mart, Best Buy, or some other popular store. It was AMES Department Store, which was bankrupt by 2002.
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Arcane Accounting Mathematics: Destroying Valuations and Shareholder Wealth
Traditional financial analysis metrics tend to muddle our insight on the intrinsic value of a company. Rather than focusing on the ability of a company to create value, which is the primary goal of the intermediate to long-term investor, these metrics lead the investors to focus on activities that do not necessarily contribute to the creation of shareholder wealth.
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Investors, other analysts, and management often rely on cash flows reported in the financials as a foundation of performance analysis and valuation. Unfortunately, those cash flows are not what they appear to be.
Many use the statement of cash flows (such as “cash flows from operations”) for judging earnings quality, measuring performance, and as key elements of discounted cash flow analysis. The cash flows reported from operations, however, are not truly from operations. Cash flows for financing do not accurately report the company’s financing activities. Cash flows reported for investing simply are not what the financials would purport.
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Home Depot (HD:USA) was a darling of the investing public from 1985 until 2001, with returns in excess of 20x the market over that period. In the era of the tech market and the internet boom, a home improvement retailer was one of the best performing stocks for a 16-year period.
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The problem with Generally Accepted Accounting Principles (GAAP) is that they create inconsistencies when comparing one company to another, and can distort a company’s true historical profitability. By making adjustments, we aim to remove the financial statement distortions and miscategorizations of GAAP. In this article we will discuss why we capitalize R&D in order to see a clearer, more accurate picture of a company’s historical profitability.
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Two simple yet interesting questions were posed recently at two Valens events. The first question, from our company Christmas party, is the type of simple query that can cause you to think very philosophically about life. The second question, from the recent APEC forum, is a loaded one about stock market forecasts. At some level, the two questions are related, and both provide ideas to contemplate for the coming year.
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Under Generally Accepted Accounting Principles (GAAP), expensing R&D in the year spent is required. For many firms, this leads to extensive volatility in profit and return calculations, and to an inadequate measure of assets or invested capital. This doubly impacts return on asset calculations, and not consistently so, thereby creating wildly different calculations of economic profit.
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