Do the numbers look good? Are profits showing an increase? Then WATCH OUT!!!! You might be being misled by numbers that are hiding in plain sight!
Let us look at one example. You are a prospective investor and as such you are mainly interested in the future profitability of a share before you decide to invest in it.
The reported operating net revenue for a particular company is as follows:
This is an industry that you would gladly invest in as you are familiar with the risks involved in it.
How much would you anticipate as the likely profit for 2018 (ignoring any other factors)?
Based on the above, you would probably expect profits to increase! The management seem to be doing a good job as they successfully increased profits from 45 million in 2016 to 60 million in 2017.
As a result, you are anticipating something like the below for 2018? Even higher perhaps.
So perhaps you should go on and invest in the shares of this business!
But we will first ask management a few questions and try to obtain some more information before we make the final decision to invest. Based on this new information the above numbers are now analysed as follows.
Oh no!!!
Now we see that in 2016 the basic operations that are still going on in 2017 and expected to continue in 2018, made a profit of 60 million and not 45 million.
The operations which the directors decided to discontinue in 2016 made a loss of 15 million. And in 2017 the basic ongoing operations made a profit of only 45, i.e. a reduction in profitability by 25%.
In 2018 these basic operations will probably do even worse! The newly acquired business in 2017 made a profit of 15 million but this does not reflect the strength of the core operations!
It seems that Total profits are showing growth only because the directors are able to find profitable businesses to acquire and to replace other profitable businesses that they turned into loss making operations before selling them on!
By looking only at financial statements without additional information could be very misleading to the readers because they would see that profits increased from 45 million to 60 million. The new additional information suggests that these directors are not really doing very well. There is in fact a risk that any good profitable business they acquire they may turn it into a loss-making operation!
Learn how to search for such information in published financial statements!