Study of Signals

[j.c.]

Investing: Don't get snowed in earnings season


(Linda Stern is a freelance writer. Any opinions in the column are solely those of Ms. Stern. You can e-mail her at [e-mail].)

By Linda Stern

WASHINGTON (Reuters) - Confused by the bad news/good news of all those earnings reports? Here's how to skip the fluff and keep your eye on the important numbers.

That's not something that's easy for most individual investors, who can get lost in the flowery prose or the numbers writ large, or the tricks some companies use to spiff up their results.

"Investors should be wary of such attempts to window-dress bad news," warned Rebecca McEnally of the CFA Institute, a professional association of chartered financial analysts in a recent statement timed to ready investors for the current earnings season.

"Net income or earnings can be easily manipulated within the income statement," said McEnally, who runs the institute's policy and standards arm.

Her group listed several tips for individual investors who want to be a little bit more professional about their approach to the flood of earnings reports coming out now. There are other consumer investor tips on the group's Web site at http://www.cfainstitute.org.

Here are some habits they suggest.

-- First, look at the cash flow statement.

It's easier to fudge an income calculation than it is to fake actual money in the bank. The cash flow statement will let you see how much money the company actually raised during the reporting period, and how it was used.

If the company is claiming big increases in net income, but there's no corresponding increase in cash coming in, that should raise a red flag.

And "too much cash on hand" isn't exactly a red flag, but if there is no cash going out for research and development or capital equipment, maybe the company won't keep up its growth pace.

-- Keep a long view, and do the math.

The CFA Institute tells investors to keep historical spreadsheets for the key numbers of companies they track. That enables you to see whether a company's patterns are changing, if its growth is slipping, and -- if you create spreadsheets for its competitors, too -- if it is performing less well than other companies in its same industry.

-- Read the footnotes.

They may explain any tricks or contortions the company went through to get the sales and income figures it's reporting.

One-time charges, expenses not counted, and sales that are counted even though they are less than legitimate -- say, sales to regional distribution centers of the company but not to consumers -- can skew the numbers of a sickly company so that it looks good.

-- Keep perspective.

Look at the company's balance sheet and income statement in terms of dollars and also as a percent of total assets.

All those zeros may make it seem like the company has a very healthy bottom line, but when that number is held against all the inventory, equipment, expenses and debt facing the firm, it might seem less significant.

-- Compare similarities.

Compare a company's quarterly performance with its performance for the same quarter a year earlier, to account for seasonal changes. Compare a company's earnings growth and debt levels with the earnings growth and debt levels of its competitors.

Compare a company's sales figures with the sales figures generated by the same stores from a year earlier. A company that grows sales every year by opening new stores is spending a lot for those sales, and will some day run out of locations.

-- Read that earnings release.

The way the company talks about its financial situation may give you clues about how honestly it deals with problems and where it expects to go.

http://news.yahoo.com/s/nm/20060128/bs_nm/column_investing_dc