As corporate profits head for a third straight period of declines during the Q3 earnings season, U.S. companies and top management are under increasing pressure to show strong results even as headwinds such as tariffs and the slowing economy weigh on results. With that in mind, experts say that investors should closely watch for companies that may use aggressive accounting to make their profits look healthier than they actually are. Companies such as Whirlpool Corp. (WHR), Keurig Dr Pepper Inc. (KDP), Mettler-Toledo International Inc. (MTD) and others have been criticized for using legal, but misleading accounting tactics, according to a detailed Barron’s report outlined in the story below.
Significance For Investors
“There are so many types of aggressive (but not fraudulent) accounting practices to choose from,” explained accounting expert Robert Willens. These accepted accounting practices include spreading expenses over several years to reduce quarterly costs, manipulating accounting reserves, massaging earnings with "abnormal items,” excessive depreciation and playing with pension accounting.
Below are four companies that have been the target of criticism.
Investor concerns about aggressive earnings tactics often occur with companies in the middle of major structural change. Among the most high-profile examples is struggling industrial conglomerate General Electric Co. (GE). Forensic accountant Harry Markopolos argues that GE has overstated the health of its long-term care insurance business, a criticism that GE has rejected as “meritless." After being removed from the Dow Jones Industrial Average (DJIA) index in June 2018, the company has seen its stock fall more than 22% over 12 months.
Shares of laboratory instrument manufacturer Mettler-Toledo sank earlier this year on a short seller's report that questioned its earnings record, as outlined in another Barron’s report. Spruce Point Capital Management analyst Ben Axler pointed to the company’s nearly perfect track record of earnings reports over the past ten years, noting that the maker of precision measuring equipment has not fallen short of the consensus estimate since 2008. Axler's one hundred page report published in July criticizes the company for using accounting practices to “smooth out economic bumps in the road,” such as capitalizing expenses. The company says Axler's report is full of "inaccurate and misleading claims,” per Barron’s.
Home appliance company Whirlpool has been called out for making unusual adjustments to its earnings statements. In particular, over the past few years, it has used earnings net of restructuring expenses. For example, in the second quarter, the firm posted EPS of $4.01 per share, which is dramatically higher than its earnings of $1.04 on a GAAP basis. Restructuring expenses accounted for $60 million of the difference in the recent quarter, and $1 billion over five years. Whirlpool did not comment on Barron's story.
Keurig Dr Pepper is an example of a company that critics say has used aggressive assumptions to bolster profits by extending its assumption for the lifetime use of its useful assets, such as buildings, machinery and customer relationships. This in turn, decreases the annual depreciation charge for these assets, boosting short term profits. The company, per Barron's, decline to comment on this criticism.
No matter what, these allegedly aggressive tactics mean that investors will have to be as vigilant as ever not only about macros trends affecting the broader market in the second half of this year, but about whether the numbers companies are reporting accurately reflect their health as the economy slows.