For the week of 3/2/20-3/6/20, we focus on the Earnings Distortion Scores (as featured on CNBC Squawk Box) for 19 companies.

Our proprietary measure of earnings distortion leverages cutting-edge ML technology featured in Core Earnings: New Data & Evidence. This paper empirically concludes that our adjusted core earnings is superior to:

  1. “Street Earnings” from Refinitiv’s IBES, owned by Blackstone (BX) and Thomson Reuters (TRI), and
  2. “Income Before Special Items” from Compustat, owned by S&P Global (SPGI)

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The paper also shows that investors with better earnings research have a clear advantage in predicting:

  1. Future earnings (Section 3.4)
  2. Future stock prices (Section 4.3)

Our Earnings Distortion Scores[1] empower investors to make smarter investments with superior data as well as defend against management efforts to obfuscate financial performance. The aggregate level of earnings distortion recently reached levels not seen since right before the tech bubble and the financial crisis.

Weekly Earnings Distortion Insights

Figure 1 contains the 15 largest (by market cap) companies that earn a “Strong Beat’, “Beat”, “Miss”, or “Strong Miss” Earnings Distortion Score and are expected to report the week of March 2, 2020. These stocks are likely to beat/miss expectations.

Figure 1: Earnings Distortion Scorecard Highlights: Week of 3/2/20-3/6/20

Sources: New Constructs, LLC and company filings

The appendix shows the Earnings Distortion Scores for all the S&P 500 companies, plus those with market caps greater than $10 billion, that are expected to report the week of March 2, 2020.

Details: KR’s Earnings Distortion

Over the trailing twelve months (TTM), The Kroger Company (KR: $29/share) had $276 million in net earnings distortion that cause earnings to be overstated. Notable unusual income in KR’s filings include:

  • $1.8 billion gain on sale related to the sale of Kroger’s convenience store business – Page 38 2019 10-K
  • $228 million mark to market gain on Ocado securities – Page 38 2019 10-K
  • $176 million gain on sale related to the sale of You Technology and Turkey Hill Dairy – Page 2 fiscal 1Q20 10-Q

The unusual income items were partially offset by:

  • $155 million charge for obligations related to withdrawal liabilities for local unions – Page 25 2019 10-K
  • $56 million charge for asset impairments – Page 44 2019 10-K
  • $42 million charge related to the impairment of financial instruments – Page 16 2019 10-K

In total, we identified $0.34/share (17% of reported EPS) in net unusual gains in KR’s TTM GAAP results. After removing this earnings distortion from GAAP net income, we see that KR’s TTM core earnings of $1.63/share are significantly less than GAAP EPS of $1.97, per Figure 2.

With overstated earnings, and a “Miss” Earnings Distortion Score, KR is likely to miss consensus expectations.

Figure 2: KR Core Earnings Vs. GAAP: 2016 – TTM

Sources: New Constructs, LLC and company filings

Figure 1 shows that KR is one of 11 companies that earn our “Miss” or “Strong Miss” rating for this week. Four companies earn our “Beat” or “Strong Beat” rating for this week.

How to Make Money with Earnings Distortion Data

“Trading strategies that exploit {adjustments provided by New Constructs} produce abnormal returns of 7-to-10% per year.” – Page 1 in Core Earnings: New Data & Evidence

In Section 4.3, professors from HBS & MIT Sloan present a long/short strategy that holds the stocks with the most understated EPS and shorts the stocks with the most overstated earnings.

This strategy produced abnormal returns of 7-to-10% a year. Click here for more details on our data offerings.

We Provide 100% Audit-ability & Transparency

Clients can audit all of the unusual items used in our calculations in the Marked-Up Filings section of each of our Company Valuation models. We are 100% transparent about what goes into our research because we want investors to trust our work and see how much goes into building the best earnings quality and valuation models.

This article originally published on February 24, 2020.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, sector, style, or theme.

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Appendix: All Major Companies Expected to Report March 2-6

Figure 3 shows all the S&P 500 companies, plus those with market caps greater than $10 billion, that are expected to report the week of March 2, 2020.

Figure 3: Earnings Distortion Scorecard: Week of 3/2/20-3/6/20

Sources: New Constructs, LLC and company filings

[1] Note that Earnings Distortion scores are also available to clients of our website.

Click here to download a PDF of this report.

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