How Did You Manage That, Western Refining?

In 2000, General Electric posted its 100^th consecutive quarter of growth in continuing operations. That's 25 years. Raise your hand if that sounds just a bit suspicious. Whatever business you're in, that feat just isn't possible unless your company's managing its reported earnings.

According to a 1998 survey, 78% of chief financial officers attending a given conference said they'd been asked to "cast financial results in a better light" without running afoul of GAAP. Half said they'd done it. Nearly half said they'd been asked to misrepresent their company's numbers, and 38% admitted they'd done so. Another survey at a different conference found that more than half of the CFOs attending had been asked to juice the numbers, and 17% had agreed to do so.

It's easy to understand why companies succumb to the incredible pressure to make it look like they've met or beaten targets or Wall Street expectations. Consistent growth is a feather in any CEO's cap, and a rising stock price often increases many executives' compensation, especially from stock options. But when companies stray from merely managing their numbers within GAAP into outright fudging them -- Enron, Sunbeam, we're looking at you here -- they can ruin themselves and their shareholders.

How can we spot suspicious earnings patterns soon enough to save ourselves? We can track how closely a company meets earnings expectations, monitor its frequency of year-over-year growth, and compare those stats to numbers from a few competitors, which should be affected similarly by changes in the business cycle. Any company that lands eerily close to earnings-per-share (EPS) expectations, and grows earnings year over year with unusual reliability, should raise a yellow flag and invite us to look closer.

Here's a look at what Western Refining (NYSE: WNR  ) , the oil refining company, has done over the past few years. I've also included a couple of other businesses playing in the same space for comparison.

Company	Reported EPS Within $0.02 of Estimates?	How Close to Estimates, on Average	How Often It Reported Growth
Western Refining	Three times in past 19 quarters	$0.03	Seven times in past 15 quarters.
Valero Energy (NYSE: VLO  )	Five times in past 25 quarters	$0.10	Twelve times in past 22 quarters.
Tesoro (NYSE: TSO  )	Three times in past 26 quarters	$0.02	Twelve times in past 22 quarters.

Source: www.earnings.com and author calculation. Difference in number of quarters counted because of data source.

In my view, there's not much to worry about for any of these three companies. Hit estimates just a handful of times, reported yearly growth at most half the time, and had several rather large misses, despite the relatively low averages. Western Refining, for instance, missed estimates by $0.10 or more 10 of the past 19 quarters. The only reason the average is so low is because those misses came in both above and below estimates. Tesoro has just as dramatic a record, with Valero being not quite as wild. Given that, I'd have to say that there's no earnings management going on here, let alone analyst management. And that's a good thing, in my opinion, indicating that management is paying attention to running the business and not running Wall Street.

Note that I'm not concentrating on managing estimates here -- though management does that, too. However, if a management team always seems to deliver on estimates time and time again, you should probably dig a bit deeper, to see whether its interpretation of GAAP is getting a bit too fast and loose.

Investors crave consistency. That's one reason why its string of reliable results spurred GE's stock price to rise so much in the 1980s and 1990s. But the real world isn't consistent, and Foolish investors should account for that. If a company's results seem too steady to be true, Fools should proceed with caution.

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