There's a disturbing tendency to exaggerate success on the rise, as confirmed by an article I read this morning.
No, the culprit wasn't another energy company like El Paso or Royal Dutch Shell
The article was about some states magnifying on-time high school graduation rates. States calculate graduation rates in different ways: Some only count students who started as freshmen and graduated, while others only use seniors who started and graduated. The variation causes concern, and rightly so.
What does this have to do with investing? Nothing more than a reminder: Caveat emptor, Fools.
Numbers make great things possible. Precise physics calculations enable space flight and navigation. But even small miscalculations can be disastrous.
In companies' and individuals' neverending competition to make more money, numbers can be powerful incentives. A CEO might say, "I want 10% growth in sales and 15% growth in net income. Find a way to hit your metrics, or you won't get stock options!"
The problem? Outside physics, numbers can be soft and open to interpretation. Science defines pressure as force divided by area. Force is force, and area is area, so the number is very precise. In business, EPS is net income divided by the number of shares outstanding. But is that net income from GAAP or non-GAAP? Were all the sales accounted for correctly? Were expenses? Does the denominator include dilution? Suddenly, EPS looks much less precise.
Remember, Fools, everyone in business has incentives based on numbers. Foolish investors should work to understand both. Read the financial statements to see how companies account for sales. If their calculations seem aggressive, take that into account. If a growth number seems too good to be true, try to find out if it is.
Numbers are powerful. Put that power on your side.
Fool contributor David Meier does not own shares in any of the companies mentioned. The Motley Fool has a disclosure policy.
