The Wall Street Journal reports on research analyzing quarterly reports (nearly 1/2 a million of them from over a 27-year period) which discovered strong circumstantial evidence that companies tweak their results to improve reported earnings. The evidence? The number 4 occurs less frequently than chance would dictate in the tenths of a cent digit for quarterly earnings. Pushing an initially calculated 0.4 cent result just a little will get it to 0.5 cent, and 0.5 cent can be rounded up to the nearest whole cent, which can make the difference between making or just missing a quarterly target.
The study, conducted by folks at Stanford, also found that that companies that later restate quarterly earnings or become charged with accounting violations report far fewer 0.4 cent results on average, compared to other firms.
The article quotes one of the study’s author, Stanford law professor Joseph Grundfest, as suggesting the pattern may be “a leading indicator of a company that’s going to have an accounting issue.” Maybe so. But now that this study has been publicized, it suggests a way to fake a signal of quality: just fudge them up to a 0.4 cent end. Be suspicious of a company that hasn’t had a 0.4 earnings result for the last ten years if they start reporting 0.4 cent results all of the time.