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Apparently designed to give a truer picture of a company’s health, investors should take them with a pinch of salt
Thursday 01 Aug 2019 Author: Mark Gardner

When companies report their financial figures, often the final figure they want you to see is not the one that simply represents all of their incomings minus their outgoings.

A growing number of firms think if you just take the statutory figures they provide, which usually stick rigidly to industry-recognised accounting standards, it doesn’t always give a true reflection of how the business is actually performing.

So often companies will adjust their figures, and push investors’ attention in the direction of things like their ‘adjusted operating profit’, which excludes one-off items and potentially gives investors a truer picture of a company’s performance based on its day-to-day activities.

Take Ocado (OCDO) as an example. The grocery distribution technology firm technically reported a pre-tax loss of £142.8m in the 26 weeks to 2 June.

But the figure Ocado wants you to look at is its adjusted earnings before interest, taxation, depreciation and amortisation (EBITDA), which stood at £18.7m.

In this case, it is perfectly reasonable to go on the adjusted EBITDA figure because the overall pre-tax loss figure includes the impact of the fire at its flagship robotic Andover warehouse in February, which cost it £99m.

Therefore, to think that the business was ordinarily making a £142.7m loss in half a year would be wrong. This is a genuine one-off item.


While adjusted earnings are meant to give a truer picture of a company’s health for better or worse, an increasing percentage of firms are conveniently leaving out the ‘worse’ bit.

Looking at red flags for earnings in the retail sector, analysts at Liberum call the above ‘profit smoothing’ and say that when a company adjusts its profit higher year in, year out, and sometimes for the same reason each year, it is a ‘clear signal of low earnings quality.’

They add that restructuring costs are a staple adjustment for many companies, ‘but there are some observers that question whether restructuring costs should be considered exceptional at all, given the fact that businesses are almost always in a state of flux.’


In the retail sector, Liberum analysts highlight Mothercare (MTC) as ‘by far the worst offender’ for adjusted earnings.

In its full-year results for 2019, it made an adjusted loss of £11.6m, compared to a statutory loss of £87.3m. The year before it reported an adjusted profit of £2.3m, compared to a reported loss of £72.8m.

The company has stripped out significant restructuring costs in its adjusted figures, but Liberum points out that Mothercare has been restructuring for the past three years, and while it would appear that restructuring is nearing a conclusion, no end date has been confirmed.

An American study by Professors Paul Griffin and David Lont suggest the adjusted earnings of some companies in the US can be manipulated, and are also often symmetric with one-time gains regularly included but not one-time losses.

One firm in the UK which has been publicly called out on such an issue is De La Rue (DLAR), the banknote and passport printer which has had a dismal time after it lost a contract to produce the UK’s post-Brexit passports, issued a string of profit warnings and is still awaiting £18m owed by the Venezuelan government.


The company enraged one of its shareholders, activist investor Crystal Amber, when it claimed in its full-year results on 30 May that performance had ‘broadly met market expectations’, with adjusted operating profit rising 6% to £60.1m.

In an update on holdings in its fund, Crystal Amber said: ‘[De La Rue’s] claims did not reflect the reality that the £60m of management-adjusted operating profits included an unexpected £7m benefit from an accounting standard change, and ignored an £18m provision charge related to the supply of banknotes to Venezuela.’

It added: ‘When we challenged chief executive Martin Sutherland as to why the share price fell so dramatically if market expectations had been broadly met, he replied that: “the analysts had got it wrong”.’ Going on the International Financial Reporting Standards (IFRS) figure as opposed to the figure adjusted by De La Rue, the company made an operating profit of £31.5m in the year to   30 March.

In Griffin and Lont’s study, they found that firms in the US were consistently reporting adjusted earnings only a little above what analysts predicted, but changed tack after people became suspicious.

Now, they claim, some companies across the pond are using all the accounting tricks to get their earnings as high as possible, so they can’t be accused of manipulation.

According to the study, on an earnings per share basis, between 2000 and 2016 a quarter of S&P 500 companies beat analysts’ expectations  when using adjusted earnings. But that percentage fell to just 10% when using their GAAP (Generally Accepted Accounting Principles) results.

So while adjusted earnings can be legitimate, it’s always worth delving deeper into a company’s accounts and not just taking their adjusted word for it.

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