If you’ve read my past postings then you know how I feel about the current financial system. Every three months, a slew of publicly traded companies start announcing their quarterly earnings. This period of time is, not surprisingly, called earnings season. Analysts and portfolio managers spend hours trying to forecast earnings per share (Net income divided by diluted shares outstanding). If you beat the consensus estimate, your company stock may go up, and if you miss, it could go down.
The truth is earnings are essentially a theoretical number. It’s based on accounting methods. In this country they use U.S. GAAP (Generally Accepted Accounting Principles). In Europe, they use a European version. Look at the name itself. Its “generally accepted”, which means it is up to interpretation. Do the companies use LIFO (Last In, First Out) or FIFO (First In, First Out) inventory accounting? Either method can change earnings. What about the company’s pension plan. Whether it is underfunded or over funded, a pension plan can change earnings drastically and can change dramatically by the expected rate of return for the pension fund. If the real estate market is depressed, a company might have to reassess the value of its headquarters downward therefore recording a loss, even if the company will never move or sell this property. Does the company use straight-line or accelerated depreciation? All these factors affect earnings and NONE of these factors have anything to do with how many products the company sells, corporate salaries, or many other operating figures. Still, the entire investment community focuses on earnings, earnings, earnings.
At Karagosian Financial, we look at earnings too, but we compare it to cash flow. What’s cash flow? It’s how much cash actually goes into the bank account. Remember Enron? Great earnings, no cash flow. If you invest in companies that actually make real money (cash flow), and not just theoretical earnings, it’ll help you avoid the Enrons of the world. In conclusion, when you pay your bills, you pay with what’s in the bank (CASH), not theoretical earnings.