Profit Fads and Slippery Slopes

Investors use a company’s profit this year as a starting point for predicting next year’s. The prognoses drive the company’s share price. 

When making those predictions, it can be reasonable and make sense to adjust the reported profit figure so that it better foretells the future. But that’s where the trouble begins. 

If your head-office burns down and leaves you with a big expense, a reasonable person will agree that the mishap probably isn’t going to recur next year. So go ahead and report a hypothetical profit figure that ignores that once-off expense.  

Slippery slope alert here. 

Indeed, while you’re at it, ignore all the expenses that aren’t reflective of what you earn from your regular operations. And why not also ignore those expenses that don’t immediately require cash to be paid. Hey, why not also ignore expenses that differ between parts of your business, like rent-in-New-York versus rent-in-Little-Rock.

These practices give so-called adjusted earnings figures, such as EBITDA, EBITDAR, EBITDAO, EBITDAX. Thesare are acronyms for...oh, never mind. Some other time. 

Before you know it, you’ve got what famous investor Charlie Munger called “bullshit earnings”. 

Don’t get us wrong… there’s a time and a place and a good argument for judicious use of reported-profit adjustments. But there’s also that business of too-much-of-a-good-thing. 

Sending eyes-wide-open regards, 

Peter

Photo by Hans Eiskonen on Unsplash