EPS Guidance Leads to BIG Problems

In a former life, I covered the restaurant industry.

Unfortunately, during that 12-year period, I was not a food critic — as has been often asked — but, rather, covered it from its financial and operational framework.

Yes, I did my share of celebrity sightseeing at the original Spago, ate in the Grill Room at the Four Seasons next to Ralph Lauren, and appeared on “Access Hollywood” predicting the demise of Planet Hollywood’s stock. But for the most part, I was mired in the trenches, looking and learning by reading earnings reports and attending analysts conferences.

I was often flabbergasted at the fluctuation of company stock when their earnings projections fell short by one penny. My financial editor, a grizzled veteran whose accomplishments included a Pulitzer for investigative reporting, explained to me the curious practice of “earnings management.”

In a nutshell, that was when companies issued earnings forecasts that often they would meet, by, ahem, any means necessary. And that would certainly include any and all creative accounting techniques.

As I recall, my colleague was one of the earliest folks to warn of the dangers of companies dispensing earnings-per-share guidance, which could ultimately lead to widespread accounting fraud.

That ominous prognostication came to a head when, in the late 1990s, my then-publication chronicled in detail the rise and subsequent demise of the Boston Market chain, which had the dubious distinction of being the first restaurant company to lose $1 billion. McDonald’s eventually saved the company from extinction, snapping it up at an almost laughable fire-sale price when compared to Boston Market’s mega-billion-dollar market cap of just two years earlier.

Not only did Boston Market basically implode, but the careers of several analysts at big-name wirehouses, who continued to tout the stock, were ruined as well.

Now admittedly, Boston Market’s problems were far more complicated than fraudulent EPS guidance, but you sort of get the idea.

Recently, the Association for Investment Management and Research surveyed over 1,000 of its members, 70 percent of whom agreed that the practice of management dishing out earnings forecasts could eventually lead to “manipulation” of financial reports. Those AIMR members participating in the poll favored company management providing them with general trend and performance information so they could draw their own inferences.

In fact, conglomerates like Coca-Cola and McDonald’s have said they would no longer issues earnings guidance,

One of the biggest knocks on the profession is that it has been reactive instead of proactive. And while that may be true, it doesn’t hurt when the profession gets help from outside parties – even if it’s as basic as to remove kindling to prevent future accounting bonfires.

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