down company, he has a double incentive to report bad earnings... It might further depress the stock so the CEO’s options strike at a lower price, and it puts the blame on the former CEO, while the new CEO will benefit from the easy comparisons and “cookie jar” going forward. Alternatively, as was the case with Tesla last quarter, it’s just one lost quarter. Why not take all of the medicine at once? Nathan Weiss of investment manager Weiss, Harrington and Associates beautifully explained what Tesla did – and why it could be good for the stock later this year... Virtually all of the accounting “maneuvers” made during the first quarter were classic earnings manipulation tactics taught in business schools (which Tesla’s CFO just finished attending): Deferred earnings recognition, inventory write-downs, provisions for future losses and one- time restructuring charges which likely incorporate costs to be recognized in subsequent quarters. Accounting textbooks and MBA case studies will surely cite Tesla’s Q1 2019 results for years to come. That said, with a bank of future earnings (and “operating cash flows”) and improving deliveries, Tesla has set the stage to potentially report (slightly) positive non-GAAP earnings in one or more quarters before year end. While Tesla’s scheme has likely backfired in the short-term (analysts “throwing in the towel” and the media reporting an “epic negative surprise” will pressure shares), the stage may be set for us to opportunistically (and temporarily) switch our “Sell” rating to “Buy for Now” in the coming quarter or two...
A ‘KITCHEN SINK’ QUARTER It’s clear to me that Tesla had a “kitchen sink” first quarter. Ironically, that could be good news for the stock. A “kitchen sink” quarter is a classic ploy whereby companies that know they’re going to have a bad quarter throw in the towel and take every charge and write-down they possibly can. This has two benefits. One, it makes the year-over-year comparison easy the following year. It also provides a “cookie jar” from which to draw revenues and earnings that can be leaked back into future quarters (when the fundamentals have presumably improved a bit to make them look better). While this is no doubt misleading to investors, it’s not necessarily accounting fraud if it’s done cleverly. Generally accepted accounting principles (“GAAP”) give management wide discretion to make dozens of assumptions that affect reported financials. As Warren Buffett noted in his 2010 annual letter, “Regardless of how our businesses might be doing, Charlie [Munger] and I could – quite legally – cause net income in any given period to be almost any number we would like.” When management abuses this discretion, its goal is usually to report higher earnings. That’s why you almost never see a company
miss earnings estimates by a penny. Management can always tweak some assumption to slightly boost earnings.
But sometimes, the incentives are reversed. For example, when a new CEO takes over a beaten-
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