INVESTING Experts say don't be fooled: Check net income and cash flow

Investors have to delve deeper before buying stocks.
Want to know how to spot the next Enron disaster -- before you buy the stock? John Meara says to remember three words: "Cash is king."
"The best advice is to follow the cash flow," said Meara, president of Argent Capital Management in Clayton, Mo. "They can't hide the cash."
The accounting scandals and the boondoggles rocking Wall Street contain a painful lesson for the average investor. You can't trust the numbers.
Corporations use pro-forma reports increasingly to disguise bad news on quarterly earnings releases. Savvy investors wait for a company's filings with the Securities and Exchange Commission to get a better handle on its condition.
But even the SEC filings can be cheat sheets. Just ask Enron Corp. investors.
To ferret out the bad stuff, today's small investors must delve deeper into the accounting.
Net income
Here's what to look for, according to a number of accounting and investment professionals:
Be skeptical of the company's quarterly earnings press release. Pay the most attention to the net-income figure. Net income is the bottom-line profit figure prepared according to generally accepted accounting principles, or GAAP standards. Regulators require it to appear in the earnings release.
Be leery, though, of terms such as "operating earnings," "cash earnings" and "pro-forma earnings." They have no solid definitions in accounting.
Some companies use such terms the right way: as a means of screening out one-time losses or gains, giving investors a better view of the core earnings. But others use them to sugarcoat disasters.
For example, Principal Financial Group, a big financial company in Des Moines, Iowa boasted "record operating earnings" and an "outstanding year" in its news release in February. But readers who wandered down to the fifth paragraph learned that net income was down 91 percent for the quarter and 42 percent for the year.
The net-income number can be manipulated, too, but at least it has a definition. "Net income is a very good measure of operating performance," said Stephen Moehrle, an accounting professor at the University of Missouri at St. Louis.
Cash flow
Then, follow the cash.
"Cash flow from operations" is a line that you'll find often on company earnings releases. You'll always find it on the quarterly and annual SEC reports that companies must file. They're called 10-Q and 10-K forms. Sometimes they're filed days or even weeks after a company's earnings release.
Cash flow from operations is money arriving in the company till, generated from its basic businesses. It's the nitty-gritty. The figure excludes a lot of fluff that can puff up profit, such as money from an overfunded pension plan.

Don't Miss a Story

Sign up for our newsletter to receive daily news directly in your inbox.