Earnings Distortion Scorecard: Week Of 10/26/20-10/30/20

For the week of 10/26/20-10/30/20, I focus on the Earnings Distortion Scores for 203 companies.

My firm’s Earnings Distortion Scores empower investors to make smarter investments with superior data as well as defend against management efforts to obfuscate financial performance.

My firm’s proprietary measure of earnings distortion (as featured on CNBC Squawk Box) leverages proprietary data featured in Core Earnings: New Data & Evidence. This paper shows that my firm’s adjusted core earnings are more accurate than “Operating Income After Depreciation” and “Income Before Special Items” from S&P Global (SPGI).

Weekly Earnings Distortion Insights

Figure 1 contains the 15 largest (by market cap) companies that earn a “Strong Beat” or “Strong Miss” Earnings Distortion Score and are expected to report the week of October 26, 2020.

Figure 1: Earnings Distortion Scorecard Highlights: Week of 10/26/20-10/30/20

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The appendix shows the Earnings Distortion Scores for all the S&P 500 companies, plus those with market caps greater than $10 billion, that are expected to report the week of October 26, 2020.

Details: Ecolab ECL Earnings Distortion Score: Strong Beat

Over the trailing-twelve months (TTM), Ecolab has -$2.3 billion in net earnings distortion that cause earnings to be understated by -$7.90/share or 269% of EPS. Notable unusual expenses hidden and reported in Ecolab’s filings include:

  • $2.2 billion loss from discontinued operations reported on the income statement – 2Q20 10-Q
  • $212 million in special charges reported on the income statement – 2019 10-K
  • $20 million in restructuring activities – Page 66 2019 10-K
  • $11 million in other special charges – Page 66 2019 10-K
  • $8 million in acquisition and integration activities – Page 66 2019 10-K

In addition, I made a $107 million adjustment for income tax distortion. This adjustment normalizes reported income taxes by removing the impact of unusual items.

In total, I identified -$7.90/share (269% of GAAP EPS) in net unusual expense that cause Ecolab’s TTM GAAP results to be understated. After removing this earnings distortion, Ecolab’s TTM core earnings of $4.96/share are much greater than GAAP EPS of -$2.93, per Figure 2.

With understated earnings, ECL gets a “Strong Beat” Earnings Distortion Score and is likely to beat consensus expectations. While I expect ECL to beat expectations in the short term, its third-quintile return on invested capital (ROIC) and expensive valuation earn it an Unattractive Risk/Reward rating, which focuses on the long term.

Figure 2: Ecolab Core Earnings Vs. GAAP: 2016 – TTM

Figure 1 shows that Ecolab is one of five companies that earn a “Strong Beat” score for this week.

How to Make Money with Earnings Distortion Data

“Trading strategies that exploit {adjustments provided by New Constructs} produce abnormal returns of 8% per year.” – Page 1 in Core Earnings: New Data & Evidence

In Section 5.2, professors from HBS & MIT Sloan present a long/short strategy that holds the stocks with the most understated EPS and shorts the stocks with the most overstated earnings.

This strategy produced abnormal returns of 8% a year.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation to write about any specific stock, sector, style, or theme.

Appendix: All Major Companies Expected to Report October 26 – 30

Figure 3 shows all the S&P 500 companies, plus those with market caps greater than $10 billion, that are expected to report the week of October 26, 2020.

Figure 3: Earnings Distortion Scorecard: Week of 10/26/20-10/30/20

Figure 3: Earnings Distortion Scorecard: Week of 10/26/20-10/30/20 (continued)

Figure 3: Earnings Distortion Scorecard: Week of 10/26/20-10/30/20 (continued)

Figure 3: Earnings Distortion Scorecard: Week of 10/26/20-10/30/20 (continued)

Figure 3: Earnings Distortion Scorecard: Week of 10/26/20-10/30/20 (continued)

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