Reported earnings don’t tell the whole story of a company’s profits. They are based on accounting rules designed for debt investors, not equity investors, and are manipulated by companies to manage earnings. This report highlights the latest loophole, Bitcoin, how its recorded in company’s financial statements, and how we treat Bitcoin to calculate more reliable measures of profitability.
Bitcoin Accounting and Its Impact on Fundamentals
As of yet, there are no formal rules for how to treat digital assets in U.S. GAAP. Instead, the American Institute of CPAs issued guidance in December 2019 that Bitcoin (and other cryptocurrency) should be accounted for as intangible assets, in alignment with Accounting Standards Codification (ASC) 305 Intangibles – Goodwill.
This accounting treatment, as opposed to recording cryptocurrency as a short-term cash equivalent or long-term investment, can have a material impact on reported financials. Recording Bitcoin as an intangible means companies can record write-downs and recognize losses on their income statement when the fair value of the firm’s Bitcoin falls below its carrying value. On the flip side, companies can recognize large, gains if they sell Bitcoin after an increase in value. This accounting treatment is in contrast to how unrealized gains/losses are recorded for other investments, like equities.
How We Treat Cryptocurrency
- remove gains/losses related to Bitcoin from net operating profit after-tax (NOPAT) and Core Earnings, as they are non-operating gains/losses
- add write-downs (after tax) back to invested capital to hold management accountable for all the money that’s been invested in the business
Bitcoin Examples from 2020 10-K Filing Season
We found several companies during The Real Earnings Season that disclosed Bitcoin as an indefinite-lived intangible asset instead of a short-term cash equivalent or a long-term investment. The following are a few notable examples: Tesla (TSLA), MicroStrategy (MSTR), and Square Inc. (SQ).
While Tesla and Square have not required any adjustments related to their Bitcoin assets as of yet, MicroStrategy’s Bitcoin investment drove material Earnings Distortion. In 2020, MicroStrategy recorded a $71 million impairment charge related to its Bitcoin assets, which was nearly 2x its 2020 Core Earnings. After removing all Earnings Distortion, which totals -$4.47/share, or 575% of GAAP EPS, MicroStrategy’s Core Earnings of $3.69/share, are significantly higher than GAAP net income of -$0.78/share.
Despite the negative effect on reported earnings in 2020, the firm issued $1.05 billion in 0% interest convertible debt in February 2021 to purchase additional Bitcoin. MSTR is down ~35% since announcing their intention to issue the debt in mid-February, which could indicate investor’s skepticism of the firm’s plan to purchase such a highly volatile and non-core asset, which has already distorted earnings.
More details on MicroStrategy’s Bitcoin purchase are in our report here.
More details on Tesla’s Bitcoin purchase are in our report here.
No Substitute for Diligence
Only our “novel dataset”, which leverages our Robo-Analyst technology, enables investors to overcome flaws with legacy fundamental datasets to apply reliable fundamental data in their research. Core Earnings: New Data & Evidence, accepted for publication by The Journal of Financial Economics also proves the superiority of our fundamental data, Core Earnings models, and securities research.
This article originally published on March 26, 2021.
Disclosure: David Trainer, Kyle Guske II, Alex Sword, and Matt Shuler receive no compensation to write about any specific stock, sector, style, or theme.