The Danger Zone Pick: 11/26/12

General Electric (GE) is in the DangerZone this week.
When digging through the company’s latest annual report, I found a surprisingly large amount of non-recurring income items that caused GE’s expenses to be understated.

GE is not doing anything illegal or, for that matter, highly unusual. However, including non-recurring income items in operating expense line items like cost of sales, SGA and depreciation is misleading. This practice is misleading because it leads investors to believe that the operating income of the company is much higher than it really is after removing the non-recurring income from the expenses.

The only way for investors to find out if companies are burying non-recurring or unusual items in the normal income statement line items (it happens in both the revenue and expense items) is to carefully analyze the footnotes and the MD&A sections of the annual reports. This work is very difficult and time consuming, but it is required for those investors who want to do their due diligence.

 

In Red Flag Report: Hidden Expenses/Income: What You Don’t Know Can Cost You, I detail the cost/benefit of analyzing the footnotes and the MD&A. Most investors will be surprised to learn that we found over 13,000 one-time items buried in normal line items in the MD&A and Footnotes of 10-K filings from 1998 thru 2/15/2011. And don’t think for a second that these one-time items are not material. During the last reported fiscal year, companies concealed over $41 billion in one-time items.