Earnings Quality

It’s just math, right?

Whatever.com just produced $1.32 in earnings…one hundred thirty two cents of Wall Street lovin’ profit. How can there be a, uh...quality to that number? A number’s a number, right?

Well. Yes. But, rather, there are different qualities of earnings. What if we told you that 100 percent of whatever.com’s earnings came from ads it sold to 40,000 different buyers, because its website was just that popular? All of the growth came intrinsically, meaning that users just loved using it and nothing meaningful changed on their balance sheet other than that the cash account went up.

Okay. Very high quality earnings.

Really? Sure ‘bout that?

Hm…well what if we told you that 70% of their ad sales came from a subsidiary in China…and were all collected in RMB (the Chinese currency)? And that, in this quarter, the Chinese currency appreciated 38 percent. Essentially, all of their big growth came because the Chinese currency did well...not because their business did well.

So…wait. Had the Chinese currency just been flat, the company wouldn’t have earned anything close to $1.32…70 percent of the sales and almost 40 percent currency gain? It means that the company happened to have a lot of sales in a country with a fast appreciating currency; it wasn't necessarily a direct reflection that the company had high quality earnings .

Yes, it's great that they were in a hot market in a highly appreciating currency. But if the currency hadn’t gone up so much relative to the US dollar in which they report their earnings, the real earnings then would have been more like a dollar. Maybe less. So that’d be low quality earnings.

What about high quality earnings? Well, really simply...you said you’d sell 300 tractors this quarter. The Street thought you’d sell 310. You actually sold 320. You said margins would be 20 percent. The Street thought they’d be 22 percent. They actually were 25 percent. You said you’d generate $20 million in cash. The Street thought you’d generate 22. And you actually did generate 25.

Simple. You just did your core business…selling tractors…well. Quality earnings. Quality tractors.