{"id":68017,"date":"2025-02-04T15:11:44","date_gmt":"2025-02-04T15:11:44","guid":{"rendered":"https:\/\/peraltafinancing.com\/accounting\/06-06-21-dont-be-fooled-by-corporate-losses-lev-end-of-accounting-blog\/"},"modified":"2025-02-04T15:11:44","modified_gmt":"2025-02-04T15:11:44","slug":"06-06-21-dont-be-fooled-by-corporate-losses-lev-end-of-accounting-blog","status":"publish","type":"post","link":"https:\/\/fivemor.com\/?p=68017","title":{"rendered":"[06\/06\/21] Don\u2019t Be Fooled By Corporate Losses \u2013 Lev End Of Accounting Blog"},"content":{"rendered":"


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A colleague opens his MBA finance class by asking the students: \u201cWho would invest in a company which reported 10 consecutive years of losses?\u201d Some of the students wonder whether they are in the right class, and no hands are raised. The instructor continues: \u201cToo bad, if you had invested in such a company, say Amazon or Tesla, you would have been a billionaire by now.\u201d<\/p>\n

\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 As you will shortly see, the instructor\u2019s case isn\u2019t an aberration. In fact, investing in losing companies, as long as you know which ones to choose, is very lucrative.<\/p>\n

\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 But first, how frequent are corporate losses? Figure 1 shows the frequency of loss reporting in the U.S. and the EU+UK. In the U.S., during the booming decade prior to Covid, almost 50% of public companies reported annual losses (middle curve), and among high tech and science-based (pharma, biotech) enterprises the loss frequency was a staggering 70% (top curve). European companies (bottom curve) display a similar trend, though the frequency of loss is a bit lower: 35-40%. Booming economies, while roughly half of public companies are in the red? Welcome to the bizarre world of accounting.<\/p>\n

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\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Figure 1 shows that the loss frequency in both the U.S. and Europe starts accelerating in the 1980s. This isn\u2019t a coincidence. The 1980s were characterized by a surge in corporate intangible investments: R&D, information technology, brands, etc. \u00a0Whole industries, essentially intangible (without heavy physical assets) emerged in the 1980s and accelerated thereafter: software, biotech, internet services providers, to name a few. Moreover, enhanced investment in intangibles\u2015the main drivers of innovation and growth\u2015characterized practically all industries, as managers realized that innovation is the key to competition, long-term. In the U.S., the aggregate investment in intangibles surpassed in the mid-1990s the investment in tangible, or physical assets, and the gap is constantly growing. Enter accounting.<\/p>\n

\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Up to the 1980s, the accounting distinction between an expense<\/em>, like salary and interest payment, and investment<\/em>, like buildings and equipment, was clear: expenses are payments for past services and therefore charged against revenues in the earnings (income) calculation, whereas investments generate future benefits and are therefore reported among assets on the balance sheet. This distinction was blurred since the 1980s.<\/p>\n

\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 Intangibles are clearly investments, expected to generate future benefits, but accountants treat them as regular expenses reducing earnings. Pfizer\u2019s $9.4 billion R&D in 2020 is recorded the same as salaries and salesperson commissions (the international accounting standards allow the treatment as an asset of a part of R&D\u2014a small step in the right direction). The absurd result: the more innovative the enterprise, the higher its accounting losses<\/em>. This accounting treatment of intangibles explains much of the sharp rise of corporate losses exhibited in Figure 1. Obviously, many of the presumed \u201closers\u201d are in fact successful growth drivers, but most investors, fixated on reported earnings, don\u2019t realize this.<\/p>\n

\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 To identify the fictional, accounting-driven losers, I (with coauthors Feng Gu and Chenqi Zhu) focused on all loss-reporting U.S. companies in the past 25 years, and added back to their earnings (losses) the intangible investments they expensed minus amortization. We thus undid accountants\u2019 folly by capitalizing and amortizing the R&D, IT, and brand enhancement (the technical procedures of capitalizing intangibles are fully explained in our study \u201cAll Losses Aren\u2019t Alike,\u201d in https:\/\/papers.ssrn.com\/sol3\/papers.cfm?abstract_id=3847359<\/a>). The result: A full 40% of loss reporters would have been profitable<\/em> without the expensing of intangibles. We term those companies \u201caccounting losers,\u201d in contrast with \u201creal losers.\u201d<\/p>\n

\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 We then examined carefully the two groups of companies and found that they are starkly different in terms of great importance to investors:<\/p>\n