Please read the excerpt from Securities Analysis below to get an idea how to apply this action step to your own securities holdings.
Balance-sheet and Income-tax Checks upon the Published Earnings Statements. The Park and Tilford case illustrates the necessity of relating an analysis of income accounts to an examination of the appurtenant balance sheets. This is a point that cannot be stressed too strongly, in view of Wall Street’s naïve acceptance of reported income and reported earnings per share. Our example suggests also a further check upon the reliability of the published earnings statements, viz., by the amount of the federal income tax accrued. The taxable profit can be calculated fairly readily from the income-tax accrual, and this profit compared in turn with the earnings reported to stockholders. The two figures should not necessarily be the same, since the intricacies of the tax laws may give rise to a number of divergences.2 We do not suggest that any effort be made to reconcile the amounts absolutely but only that very wide differences be noted and made the subject of further inquiry.
The Park and Tilford figures analyzed from this viewpoint supply the suggestive results as shown in the table on page 436.
The close correspondence of the tax accrual with the reported income during the earlier period makes the later discrepancy appear the more striking. These figures eloquently cast suspicion upon the truthfulness of the reports made to the stockholders during 1927–1929, at which time considerable manipulation was apparently going on in the shares.
This and other examples discussed herein point strongly to the need for independent audits of corporate statements by certified public accountants. It may be suggested also that annual reports should include a detailed reconcilement of the net earnings reported to the shareholders with the 2 See Appendix Note 51, p. 787, for a brief résumé of these divergences. net income upon which the federal tax is paid. In our opinion a good deal of the information relative to minor matters that appears in registration statements and prospectuses might be dispensed with to general advantage; but if, in lieu thereof, the S.E.C. were to require such a reconcilement, the cause of security analysis would be greatly advanced.
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