In the realm of stock analysis, accurately forecasting company earnings requires a comprehensive understanding of financial metrics. The challenge arises from the limited visibility many analysts have into a company’s true financial health due to the lack of access to or consideration of proprietary footnote data. Traditional measures of earnings, like “Street Earnings,” can be misleading as they often include non-operating income, which may inflate a company’s financial performance. By removing this kind of income and focusing on what is categorized as “Core Earnings,” a more realistic view of a company’s profitability can be attained. My team employs a thorough examination of thousands of footnotes in earnings reports to identify the outliers—stocks that are most likely to fall short of market expectations in forthcoming earnings releases.
In the analysis of S&P 500 companies, we have found that a significant percentage has overstated its earnings through the conventional measures used in the market. For the trailing twelve months (TTM) concluded on June 30, 2024, we observed that 369 companies—about 74% of the S&P 500—reported Street Earnings that exceeded Core Earnings. Interestingly, this number is only slightly lower than the 373 companies reported in the previous quarter. Most alarming is that a substantial portion of these companies—210 to be exact—have their earnings overstated by more than 10%. Despite a minor decrease in the number of companies with such distortions compared to the earlier quarter, they still constitute a significant share of the S&P 500’s total market capitalization.
The financial implications of overstated earnings are quite profound. The 369 companies with Street Earnings higher than Core Earnings account for approximately 66% of the total S&P 500 market cap as of the end of September 2024. This notable statistic suggests a systemic issue where inflated earnings could mislead investors and analysts alike, distorting their understanding of market conditions. With an average distortion of 19% in overstated earnings across the index, it becomes clearer how further analysis and a refined methodology—like that offered by our Robo-Analyst technology—are essential in identifying these discrepancies.
As we delve deeper into our findings, particular attention should be called to the company we predict is most likely to miss its earnings targets for the third quarter of 2024. This prediction is grounded in the analysis of how Street Earnings correlate with historical performance while noting that errors in past Street EPS significantly affect future earnings estimates. Given that many investors tether their projections to historical data, our assessment indicates that this particular company stands on shaky ground due to discrepancies between reported and actual financial performance.
One must also recognize the cost associated with conducting such thorough analyses; we estimate that replicating our in-depth footnote examination would exceed $2 million for many firms each quarter. This approximation highlights the value of our approach and the necessity of a skilled team dedicated to parsing through complex financial statements filed with the SEC. Without this level of scrutiny, analysts may unwittingly endorse companies on the brink of disappointing earnings announcements.
In conclusion, the ability to discern true financial performance through Core Earnings—a methodology supported by meticulous footnote analysis—presents a competitive edge in today’s investing landscape. As our findings show, reliance on superficial earnings metrics can lead to greater market inefficiencies. By equipping ourselves with a clearer understanding of underlying trends, including the critical identification of stocks that are at risk of disappointing in their earnings projections, investors and analysts can make more informed decisions, enhancing the overall integrity of stock market analysis. This framework not only serves to highlight potential pitfalls but also, crucially, aids in shaping more substantial investment strategies going forward.
