June 2023

To Our Business Partners


Investors have in recent years become enamored with companies reporting earnings that “beat (or miss) the estimates.”  This is a relatively recent phenomenon in the long history of investing.  Companies have learned to play the game, offering “guidance” to the investment community that they have a good chance of meeting or exceeding profit estimates.  Company executives have always had ways to manage earnings, but they often reach extremes in managing (manipulating?) earnings as economic cycles show signs of age, particularly as revenue growth slows.  According to a recent Wall Street Journal article, one measure of earnings manipulation is now at its highest level in more then 40 years.

While many of these moves are allowed under the long-standing “Generally Accepted Accounting Principles” (commonly known as GAAP), some are borderline acceptable.  A common practice recently has been to provide a set of “pro forma” results that do not conform to accounting standards.  Companies emphasize these “adjusted” numbers instead of the income/expense numbers reported under GAAP.  Income statement purists like us might prefer the sarcastic label given to these adjustments:  EBBS – “Earnings Before the Bad Stuff.”  In other words, companies and most analysts make the case that the “bad stuff” should be excluded from per-share income for one reason or another.

Some of the more common methods of manipulation include: changing the useful life of depreciable assets to reduce depreciation expense; timing of revenues; shifting costs of employee stock grants to a different time period and unwinding prior charges; backing out non-recurring expenses that actually recur; accelerating stock buybacks.  Thankfully, the Securities and Exchange Commission (SEC) is monitoring these activities and has warned companies that they must fully reconcile any adjustments to ensure the transparency of quarterly earnings reports to investors.

Long-term earnings power and quality of earnings are extremely important in our stock valuations.  When analyzing companies, we must be acutely aware of the revenue and expense components of the profit-and-loss statement, and make our own adjustments, if necessary.  This quarterly earnings game has become more widespread at a time when the economy appears to be slowing and companies reach to meet investment community expectations. While overall valuation levels remain high, they may be higher than they appear to be in some cases due to the upward manipulations of earnings.

As an aside, your writers wonder why stocks often get severely punished when their companies “miss” analysts’ earnings estimates.  Shouldn’t the self-important analysts be severely punished instead for their analytical errors?


Our group of widely-held stocks* rose to 86% of estimated value.  We continue to wait patiently for price markdowns to acquire more companies at bargain prices.  Remember always that low prices-to-values yield satisfactory future investment returns.


Stock market indexes were mixed in May, with only two indexes recording positive results:  the NASDAQ Composite and the S&P 500. Both were strongly influenced by only 7 mega-capitalization technology stocks that are involved in the now-popular “Artificial Intelligence” (AI).  This machine-based intelligence concept has pushed related stocks to astronomical valuation levels.  AI-generated earnings would have to grow at very high rates for a very long time to justify the lofty valuations.  This rarely happens.  All the other indexes we monitor were down 1-4% for the month. Similarly, year to date, most indexes are down 1-2%, while the S&P 500 and the NASDAQ were up 9% and 23%, respectively. Over the last 12 months, gains in the S&P 500 and NASDAQ have masked a general decline in “the market.”  Our group* of portfolio stocks have matched the moderate declines of the broader indexes over the past 3 months, year-to-date, and past year.

Steve Nichols, CFA • Bill Warnke, CFA •  Andy Ramer, CFA

*The group of “portfolio stocks” — our Equity Composite for the purpose of evaluating investment performance — consists of 19 stocks that are held in our clients’ accounts. Portfolios might hold some or all of these stocks, depending on investment guidelines unique to each client, the timing of purchases and sales, and start dates of accounts. The performance of this group of stocks is a good proxy for our equity performance but might vary widely among accounts. Of course, past performance is not necessarily indicative of future results.

We hereby offer to deliver to you without charge a copy of our current Form ADV Part 2, in accordance with the U.S. Securities and Exchange Commission’s “Brochure Rule.” Please contact us if you would like us to send you a copy.