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Should you believe that earnings announcement?

Not necessarily…

A new study provides further evidence suggesting many companies tweak quarterly earnings to meet investor expectations, and the companies that adjust most often are more likely to restate earnings or be charged with accounting violations.

The study, which examined nearly half a million earnings reports over a 27-year period, reached its conclusion by going beyond the standard per-share earnings results that are reported in pennies and analyzing the numbers down to the 10th of a cent.

That deeper look showed that companies tend to nudge their earnings numbers up by a 10th of a cent or two. That lets them round results up to the highest cent. Investors often snap up shares of companies that beat earnings expectations, even by a cent, and, likewise, sell off shares of companies that don’t make their numbers.

“Managements will exercise accounting discretion to try to make their numbers look better for Wall Street … in a number of subtle ways,” said Joseph Grundfest, one of the study’s authors. Mr. Grundfest is a law professor at Stanford University and a former member of the Securities and Exchange Commission.

Mr. Grundfest and co-author Nadya Malenko, a doctoral candidate at the Stanford Graduate School of Business, said the accounting maneuvers may be legal, even when they have the effect of boosting reported earnings per share. Most of the tactics involve judgment calls, such as the value of inventory or the amount that should be set aside for loans that won’t be repaid. The Securities and Exchange Commission declined to comment.

Continue Reading (WSJ)

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