by Rachel Bradley
  Equity Analyst, Gradient Analytics LLC (a Sabrient Systems company)

At times, there are conflicts of interest between a company’s management and its investors, specifically shareholders, which creates a structural agency problem. So, it is common for companies to try to align the monetary interests of management with shareholders by awarding a large part of executive compensation in equity. As a result, management performance metrics often create an incentive to present the current period financials in the best light possible, even if it is unsustainable in the longer-term. This dynamic creates opportunities for a forensic accounting firm like Gradient Analytics, which specializes in assessing the quality of reported earnings of publicly traded companies to both vet long candidates and to identify short candidates.

An astute investor might ask the perfectly reasonable question, “If publicly traded companies are regulated and audited, then aren’t all reported earnings of passable quality?” However, consider that it is possible for a company to engage in “earnings management” by publishing financial statements that may mislead investors as to the firm’s true financial health without violating accounting standards. Moreover, we would argue that even though two given companies both followed GAAP accounting standards and received clean opinions from their auditor, earnings growth at Company A may be dramatically more sustainable than at Company B. Of course, it can be quite valuable for an investor to know when a firm is showing signs of unsustainability in its reported earnings growth.

In this article, I use three real-life examples to provide a high-level overview of our analysis process, which includes assessing earnings quality, anomalous insider trading activity, audit control risk, and corporate governance. Although Gradient does not employ a team of investigative journalists to knock on doors, interview company employees, or rummage through the trash for evidence, our comprehensive analysis of the published financial statements (and, importantly, the footnotes) can help stack the odds a little bit more in investors’ favor.  Read on....

  by Bradley Cipriano, CPA
  Equity Analyst, Gradient Analytics LLC (a Sabrient Systems company)

As interest rates remain at historic lows, mergers and acquisitions (M&A) have soared in recent years. With the rise in M&A activity comes a rise in accounting complexity, introducing a plethora of ways that management can cosmetically improve their as-presented results – and mislead investors. Gradient Analytics specializes in forensic accounting analysis that helps to uncover these types of financial shenanigans, including overstated assets and revenues, understated liabilities and expenses, and weakening earnings quality. This type of analysis is useful for both vetting long positions and generating short ideas.

In this article, I describe four acquisitions that we believe were used to obscure underlying financial weakness at the parent company by temporarily shoring up growth and earnings. Key takeaways are how management can utilize acquisitions, purchase price accounting, and non-GAAP adjustments to optically improve their as-presented results. In each case, the theme will remain consistent: the acquiring company was under fundamental business stress.

The subject transactions include:

• SodaStream (SODA) acquisition of its distributors in 2012 and 2013
• SNC-Lavalin (SNC) acquisition of WS Atkins in 2017
• Belden Inc. (BDC) acquisitions in 2017 and 2018
• The Walt Disney Corporation (DIS) acquisition of 21^st Century Fox in 2019

Read on....