Professional Manipulation might be the concurrent practice in every field or profession, with objectives like positive or negative, legal or illegal and from sports to stocks.Financial analysis follows systematic and straightforward approach, yet wider components have to be considered while doing financial research. Every analyst has his/her own set of parameters to evaluate the performances to take decisions. As financial has been carried out with predefined input that can be available from different resources like Corporate Financial results, Investor meetings, Discussions with Analysts covering particular companies, media and other.
The input has been provided obligatory on the predefined formats around the world, but thanks to the accounting tricks that the given data can be smoky after manipulation for personal interests. Let’s review one of the manipulation tactics to get you aware how to avoid its negative outcomes.
Today we delve into the Manipulation of EPS or Earning per share’ the very basic tool that most of the investors both rookies and pros use to calculate the potential earnings worth of any company. I have already discussed about P/E or price-to-earnings ratio in one of the previous article here. EPS is the vital component of P/E calculation.
EPS represent after-tax earnings over a certain period of time, calculated quarterly as well as yearly by dividing Net profits by number of shares. GAAP (Generally Accepted Accounting Principles) make sure that EPS have to be provided in financial statements under legal obligation.
Manipulated EPS practice usually met the legal requirement but not truly reflect earnings position of the respective company. Any variation in EPS or Earning guidance trigger caution among expert investors due to the uncertainty of the future and the fact that management can easily manipulate the earning and its guidance, while secure their position on the plea of uncertainty. Of course manipulated earnings mislead innocent investors as they can make bad investment decisions.
Basically EPS is widely calculated with guidance and future earnings forecast to determine the targeted share price in specific time frame. The calculated figures than compared with the past figures during same time period, for example’ March 2009 annualized EPS forecast is compared with actual March 2008 EPS to ascertain the company growth prospects.
During bullish market management can give optimistic forecasts, as market wants accelerated stocks with fast-growing EPS, contrary to bear markets when they may provide lower guidance so that they can out beat the forecasts during earnings season. It is vital to evaluate management expectations or guidance when these expectations are too optimistic or too pessimistic. Ironically this is something that many investors forgot to do on number of times in the past.
Management team also considers manipulation of financial statements to report profits in a format that will help them earn their bonuses. You might not aware but it is fairly normal to assume that the income statements overstate profits. There are different ways for any management intentionally uses manipulation tactics to boost income figures, like delaying payable to input suppliers, selling securities held or restructuring reserves by reversing the amount transferred during prior quarters or even showing the inventories laying with the sales channels as accrued income deemed as final sales, for example:
For increasing the Income figures, management of the company can offer sales channels or retailers any incentives such as extended money back guarantee on unsold stock of goods/inventories. This way finished goods inventories move into the distribution channel and the credit sales have been registered in company books and accrued/outstanding earnings figures increased, but actual cash might never be received, because of the inventories returned as per terms of guarantee, this may increase sales in one quarter or so.
Now you probably start thinking, how can we evaluate the real earning figures of particular company to avoid being invested with manipulated figures?
Well, the solution is quite simple in comparison to the critical problem of EPS manipulation. You can always determine the actual earnings position with help of operating cash flows. Operating cash flows figure consists of net Cash inflows or outflows from operation activities, simply How much cash the company has generated from its actual business activities and not included cash flows from supplementary activities like investments etc.
Practically operating cash flows consists of net income from income statement adjusted after adding or subtracting non operating cash inflows or outflows, Outflow like depreciation on asset is a non-cash charge so got added back, the same treatment is vetted to pending receivable (cash inflows accrued but not received yet), payable, interest or dividends and stock inventories.
I hope you are now able to do your analysis more precisely to make investment in particular stock as operating cash flows are very easy to calculate, anyone can calculate cash flows quickly and this you should always do, because cash flows are much better option from window dressed EPS.
There are also other forms of manipulation activities that I’ll write about some other time, so don’t forget to stay tuned. Now while concluding this article, let me remind you as always that whenever you are making investment decisions, remember its your hard earned money you must make sure you do your homework well before putting it in any venture.
EPS Investing Cash flow Review Manipulation Income Accounting Analysis Financial Stocks Management Research Information Profession P/E GAAP Valuations Guidance Markets Operating Cash-inflows cash-outflow Inventory Decision-making Money Statements
