The views expressed here are those of the author, the publisher of Income Securities Investor.

By Marty Fridson

NEW YORK, July 17 (Reuters) - As the latest earnings season kicks off, here’s your regular reminder that tricky number-counting is all too common in the corporate world and can have dramatic consequences even when everything is perfectly legal.

Some examples of twisted tabulations have been around for decades.

When Jack Welch ran General Electric GE.N from 1981 to 2001, he was intent on reporting an earnings per share (EPS) increase in each successive quarter. Business does not really work that way, of course, as fluctuations in economic activity and competitive conditions inevitably inject some volatility into profits.

Nevertheless, GE’s divisional managers felt intense pressure to do their part in maintaining the illusion of a straight, upward-sloping EPS line. Accordingly, if their earnings looked certain to fall short as a quarter-end approached, they would sometimes solve the problem by hurriedly making an acquisition.

Under accounting rules, the division could add the acquired company’s earnings for the whole three-month period to its existing earnings, enabling it to meet its Welch-imposed quota.

Suffice it to say, this was not a recipe for long-term financial health. GE saw its market cap shrink by roughly 74% in the 20 years after Welch stepped down.

More recently, concerns arose about accounting practices potentially propping up earnings at IT services provider Kyndryl Holdings KD.N when the Securities and Exchange Commission made a document request this past February.

This came 10 months after Gotham City Research published a report noting that the company’s auditor had cited a material reporting weakness related to revenue recognition. Gotham also pointed to metrics such as Days Sales Outstanding and capitalized costs, which were way out of line with peer companies.

The company’s stock plunged 55% the day the SEC request was announced.

STUFFED

Channel-stuffing is another way of making the numbers say what management wants. In 2001, pharmaceuticals producer Bristol-Myers Squibb BMY.N gave its wholesalers discounts as incentives to purchase its drugs at a faster rate than necessary to fill prescriptions at pharmacies.

That action did not increase sales, which would have been a financially rational motive for offering a discount. It merely shifted sales from a future period to the present to inflate current earnings.

BMY’s actions caught up with it in 2002, when management announced that its first-quarter EPS would be about 20% below analysts’ consensus forecast. On that day, the stock slumped by as much as 14% in after-hours trading.

Semiconductor manufacturer M/A-COM Technology Solutions Holdings MTSI.O found itself in a similar situation roughly a decade later. In 2015, it met analysts’ revenue expectations for its first quarter, but it did so with the aid of an accounting change.

MTSI switched from recognizing revenue when its distributors made final sales to end users to recognizing it upon sale to distributors, which accounted for about a quarter of its total sales.

Suspicions of channel-stuffing arose, and the numerical contortions eventually caught up with the company. MTSI reported misses on revenue, gross margin, and adjusted EPS for its third quarter in 2015, in addition to issuing fourth-quarter guidance one-third below the low end of analysts’ estimates. Its stock plummeted 20% at the next day’s opening.

In none of these cases were the companies charged with doing anything illegal, but the consequences were significant nonetheless.

CREATIVE LICENSE

Moving to this past June, there was a novel example of a company making progress toward a stated numerical target with a questionable tactic.

The story begins with the July 2024 merger agreement of Paramount Global and Skydance Media.

Many Hollywood screenwriters voiced concern about this entertainment industry consolidation, arguing that it threatened to reduce the amount of work available to them. Against this backdrop, Paramount PSKY.O declared that it would step up its releases from eight in 2025 to 15 in 2026.

Fast forward to last month. Paramount released "Jackass: Best and Last," the finale in a film franchise in which a troupe of performers engage in stunts. Much of the movie consists of reused footage from previous "Jackass" movies, supplemented by a limited number of new scenes.

Paramount produced this flick at an estimated cost of just $10 million. To put that number in perspective, among all planned or completed 2026 releases by the “Big Five” movie studios – Columbia (Sony 6758.T), Paramount, Universal CMCSA.O, Warner Bros WBD.O, and Walt Disney Studios DIS.N – with production budget estimates on IMDb, the median was $80 million, with two films tying for the top spot at $250 million.

Only four of the 19 films included in this sample had estimated costs below $30 million, with the lowest, other than "Jackass: Best and Last," being $18 million.

Based on these estimates, Paramount was able to check one box on its slate of 15 promised releases by spending roughly half as much as it did on its least costly recent film, while providing little new work for creatives in the process.

To be clear, nothing about this violated any law, and it was not related to any earnings target. It’s also impossible to know whether the justification for this particular film was related to the quota – or whether the on-the-cheap production was simply part of a broader strategy.

But regardless of the motive, the company was able to show progress toward the letter of a stated objective, while leaving the spirit on the cutting room floor.

All of these examples are reminders that we should scrupulously examine the facts every time a company claims to have achieved a milestone.

College track and field recruiters would not hand out a scholarship to a high school sprinter who set a state record by moving the finish line closer to the starting line. Investors should be every bit as careful when they are doling out money.

(The views expressed here are those of Marty Fridson, the publisher of Income Securities Investor. He is a past governor of the CFA Institute, consultant to the Federal Reserve Board of Governors, and Special Assistant to the Director for Deferred Compensation, Office of Management and Budget, The City of New York.)

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