The financials disclosed in quarterly earnings reports are treated like the gospel by investors. But according to a new paper by researchers at the Harvard Business School and MIT’s Sloan School of Management, the headline numbers may not always be as accurate as they should be.
David Trainer is the CEO of New Constructs. The company's data was used by the authors of the paper to show how certain more useful numbers were “hidden” in disclosures.
Companies sometimes intentionally obscure what’s really going on, and traders using some commonly watched numbers are at a disadvantage, Trainer said.
“Very few people have the time to go through [10-Ks and 10-Qs],” he said on a recent edition of Benzinga’s PreMarket Prep.
“Too few people are reading footnotes. And there’s a lot of noise in earnings.”
The paper's authors said traders make more when they take the "hidden" numbers into account.
"Street earnings for firms that meet or just beat analyst expectations are more likely to selectively exclude these items," the paper said.
"Trading strategies that exploit cross-sectional differences in firms' transitory earnings produce abnormal returns of 7-10% per year."
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— New Constructs (@NewConstructs) October 10, 2019
Trainer said the more comprehensive New Constructs data used in the paper comes from his company's process of combing through footnotes and other elements of corporate disclosures.
Even commonly cited adjusted numbers, like non-GAAP earnings, are missing much of the information that can help investors make better decisions, the New Constructs CEO said.
"Non-GAAP tends to be the number the company makes up to say whatever they want the product to be," Trainer said. "Non-GAAP is really misleading. I highly recommend people avoid looking at that number."
Accounting metrics like price-to-book and price-to-earnings were "never really designed for investing," he said.
"They’re highly manipulated [and] they’re incomplete."
It's often not in the company's interest to want analysts and investors to easily be able to use the data, Trainer said.
"There are people who are effectively preying on the overreaction to noisy numbers all the time."
Listen to the full interview with David Trainer at 34:50 in the podcast below, or watch the clip on Youtube here.
PreMarket Prep is a daily trading show hosted by prop trader Dennis Dick and former floor trader Joel Elconin. You can watch PreMarket Prep live every day from 8-9 a.m. ET here. The replay can be found on Benzinga's YouTube channel, and the podcast is on iTunes, Google Play, Soundcloud, Stitcher and Tunein.