Return on equity (ROE), a measure of profitability in relation to the equity in a business, is another popular metric that can mislead investors. From its reliance on accounting earnings to its susceptibility to manipulation (often to benefit executive compensation), ROE lacks the necessary analytical rigor to support diligent investment decisions. Investors that rely on ROE are in the Danger Zone. Unattractive Stocks with Misleading “Profitability” For a number of reasons that we’ll discuss below, ROE can make companies appear much more profitable than they truly are. Figure 1 highlights the five Unattractive-or-worse rated stocks with the most misleading ROEs in

While analysts hail “the best earnings season in 13 years,” the market has delivered a solidly lackluster response. Over the past month, the S&P 500 is down roughly 1% despite a string of earnings beats. With valuations this stretched, the market no longer appears willing to reward companies merely for beating quarterly expectations. Perhaps more investors now understand that GAAP net income numbers omit valuable information. They include non-operating items, are subject to manipulation, and don’t account for the cost of capital. GAAP earnings don’t drive valuation. What investors should focus on are economic earnings, which make adjustments to exclude

Uncertainty defined 2016. Analysts tried in vain to predict the Fed’s actions on interest rates. Changing commodity prices defied investor expectations. And of course, the presidential election provided ample drama for the markets. In the midst of all that uncertainty, investors grew more and more aware of the need for real diligence. The market is increasingly aware that the accounting constructs reported by companies (especially those non-GAAP results) don’t always represent the underlying economics of the business. In 2016: Big institutional investors began pushing companies to tie executive compensation to return on invested capital (ROIC) instead of GAAP EPS. The

Sir David Tweedie, then Chairman of the IASB said, “One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet."