Investors fear use of clever accounting to trip bonuses
Gap between stated and adjusted profits for FTSE 100 companies at widest in a decade
Large investors fear FTSE 100 companies are using clever accounting techniques to trigger high executive bonuses and mask poor financial performance.
The concerns come as research shows the difference between stated and adjusted operating profits for the UK’s top-100 quoted companies is at 51 per cent — the widest gap in a decade. In 2007 the split was just 15 per cent.
Russ Mould, investment director at AJ Bell, the investment company that carried out the research, said the figures suggested equity markets were nearing “the top of a cycle”.
“As growth gets harder to generate, there is a temptation to employ different financial tactics to generate it, either to appease return-hungry shareholders or hit bonus triggers,” he said.
“If a share price suddenly turns and the economic cycle turns with it, investors [will be left] wondering why something that looked like a sound investment on paper is now a terrible one in reality.”
Companies adjust profit figures to take into account one-off expenses such as acquisitions, restructuring costs or fines. The revised figures are typically higher than actual profits booked, and are an important metric when determining executive bonuses.
The growing use of revised profit figures have made shareholders and analysts increasingly wary of these numbers, according to Andrew Millington, head of UK equities at Standard Life Investments, one of Britain’s largest fund companies.
“This is on our radar, and it is a concern,” he said. “There is a real danger if you are investing without actually going back to the accounts.”
The FTSE 100 companies that posted the biggest gap between stated and adjusted profits over the past 10 years were mining group Glencore (15,175 per cent gap), housebuilder Taylor Wimpey (736 per cent) and Lloyds Bank (393 per cent).
Glencore said its profit gap was large due to the near $11bn of impairments the company took on completing its acquisition of Xstrata in May 2013.
Mr Millington blamed the growth in the use of adjusted profits on pay for management teams increasingly being linked to revised earnings, and low interest rates supporting an M&A boom.
“We would hope to see the gap [between stated and adjusted profits] start to close for the market as a whole. In the meantime investors have to be sceptical of using adjusted numbers,” he said.
Companies that substantially adjust profits over extended periods have frequently underperformed for shareholders, the research also showed.
The five FTSE 100 companies that generated the worst total shareholder returns over the past decade had large net profit gaps of between 58 per cent and 1,000 per cent over that period. They include supermarket chain Tesco; UK banks Barclays, RBS and Lloyds; and mining group Anglo-American.
By contrast four of the best five in terms of total shareholder return over the period — Ashstead, Hargreaves Lansdown, Croda and Randgold Resources — had small net profit gaps of less than 10 per cent.
David McCann, an analyst at brokerage Numis, said more companies were reporting adjusted profit figures as “it is becoming harder to deliver growth in a low return environment”.
“Companies are looking for ways of showing optical growth so they don’t have to report declining results. Manager pay is increasingly being linked to earnings-based measures, so there is increasing motivation to boost those measures,” he said.