The real test of profitability will be in the pudding.
"Management discretion” in accounting provides great flexibility to allow management to make the picture look good in the short term, say the latest quarter. As the future evolves, it is more difficult to "hide" adverse circumstances as ensuing periods are reported. Absent committing fraud, the real effects on a company's income statement and balance sheet will eventually surface. They can good or bad.
Consider this. Many tech companies laid off workers. This means those regular salaries are not hitting their expenses. Assuming revenues hold or drop just a little, the difference between revenues and total expenses (gross and operating) grows. This means income grows. Add in corporate buybacks funded by the cash saved with layoffs, the earnings per share grows. But this can only happen for the short term. Eventually, cash income catches up with accrual income.
If you have ever been in a company where there were significant layoffs and survived the layoffs, often a lot of the work has to be dispersed over the remaining workers. If the revenues associated with reduced expenses are properly reduced, the benefits of a layoff can be properly executed. But, if the revenues are kept while the people paid to support those revenues are reduced, significant problems are likely and they will show in various ways in the coming periods.
So be aware that one period does not define a trend and, as an investor, do not put too much weight on a single period.
Be smart, be well-read, be aware and be successful.
“Finally, an important warning: Even the operating earnings figure that we favor can easily be manipulated by managers who wish to do so. Such tampering is often thought of as sophisticated by CEOs, directors and their advisors. Reporters and analysts embrace its existence as well. Beating “expectations” is heralded as a managerial triumph.”
“That activity is disgusting. It requires no talent to manipulate numbers: Only a deep desire to deceive is required. “Bold imaginative accounting,” as a CEO once described his deception to me, has become one of the shames of capitalism.”
- Warren Buffett - 2023 Letter to Shareholders
