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ProForma Earnings

ProForma Earnings
They have found a way to fudge the earnings reports and you should know about it. Some companies are trying to deceive investors with the socalled proforma modification of earnings. Tonight I attempt to explain what proforma earnings are when they are useful and how companies use them to trick investors. 

What Are Proforma Earnings
In short proforma is a financial statement that does not reflect write downs or goodwill.  Goodwill is the excess of the purchase price over the fair market value of an asset. Accountants record this as a 'write off' in the financial report.  This type of accounting trick is used to make earnings look much better.  What you should be looking at is net income.  Net income is what really determines the profitability of a company. 

Sometimes however net income does not tell the whole story when a company has onetime charges that are not relevant to future profitability. Some companies therefore strip out certain costs that get in the way. By omitting items that reduce reported earnings this process can make a company appear profitable even when it is losing money.  In other words proforma is everything but the bad stuff.  Proforma earnings are designed to give you a clearer view of a company's operations. The problem is that there is not much regulation of proforma earnings so sometimes companies bend and abuse the rules to make earnings look better. A broker will focus closely on whether or not the company beats or meets expectations and heavens sakes if they miss the number. 

How about the average main street investor its earnings day and a company released its earnings report Let's say that the company missed its earnings estimate on a nonproforma basis but they release the report with the headline stating they beat the proforma expectations.  If all the dumboberry see's is that they beat the estimate he is going to jump on the stock with the rest of the herd and the stock gaps up at the open.  The professional knows the real deal and will short sell the gap.  The stock reverses and goes down leaving all of the amateur investors dumbfounded.  They ask how can the stock go down with that great earnings report Answer it is reported as proforma but unfortunately they do not know what proforma is.  The professionals will dig behind the fluff of the news release and look at the nonproforma earnings for the real answers.  

ProForma Tricks
Companies all too often release profitable earnings that exclude things like stockbased compensation and acquisitionrelated expenses. These companies are expecting the average investor to forget that these expenses are real and need to be included.  Sometimes companies even take off unsold inventory when reporting proforma earnings. That inventory costs money so why should they be able to write it off It is bad management to produce goods that cannot be sold and a company's poor decisions should not be erased from the financial statements. 

Companies are not always dishonest with proforma earnings. Proforma does not mean that the numbers are automatically being manipulated.  However be skeptical when reading proforma earnings because it may save you big money. To evaluate the legitimacy of proforma earnings make sure that you look at what the excluded costs are and decide whether or not these costs are real.  Proforma is supposed to give investors a clearer view of a company's operations. For some companies proforma makes a lot of sense because of the nature of their businesses they are constantly writing down big depreciation costs.  Proforma earnings are informative when official earnings are blurred by large amounts of asset depreciation and goodwill.  Intangible things like depreciation and goodwill are okay to writedown occasionally but if the company is doing it every quarter it might be time to raise the bull $hit flag.

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