Tuesday, September 20, 2022

Not Every Company Adjusts Earnings, Like This Very 'Boring' One

By Herb Greenberg

Some businesses are so straightforward and boring that they don't have to twist anything to make the numbers look better than they are...

Consider Fastenal (FAST), an enormously successful company that distributes screws, nuts, and bolts.

A business doesn't get more boring than that...

I mentioned the company in the most recent issue of my Investment Opportunities newsletter as an example of just how boring some companies can be, yet over time how being boring can be beautiful for investors.

Not by the standards, of course, that some investors became accustomed to during the market's melt up. In the past 10 years, FAST shares have merely doubled... But over 20 years, they have shot up by 10 times.

For me, Fastenal was the perfect narrative to introduce this month's Investment Opportunities recommendation – a company that actually makes Fastenal look exciting...

As I wrote in the issue...

Fastenal is in the business of selling "threaded fasteners," better known as screws, nuts, and bolts.

Did you know there are at least 25 varieties of screws?

Wood screws, sheet metal screws, machine screws, self-drilling screws, drywall screws, dowel screws... (It's enough to make me feel like Bubba reciting shrimp dishes from Forrest Gump.)

Then, within each variety, there are different types of screws, sorted by grade, length, thread size, and finish, not to mention the kind of head... including flat, hex, and contour truss.

Fastenal sells 1,563 different types of sheet metal screws alone, as well as 3,270 different kinds of nuts and 9,996 kinds of bolts.

Boring as it may be, Fastenal is also a fascinating success story... not just as a business, but as an investment. It's the epitome of why, when it comes to investing, boring can be beautiful.

In other words, I had Fastenal on my mind for the latest Investment Opportunities recommendation. (If you aren't already a subscriber, you can find out how to gain instant access to it right here.)

So when I saw my friends Jeff Middleswart and Bill Whiteside mention it in their Peek Behind the Numbers newsletter, my first thought was, "Oh no, they're publishing something negative on it."

Jeff and Bill tend to do terrific forensic analytical work, so my obvious concern was that I had picked the wrong company to use as a positive example.

As it turns out, they liked Fastenal, too... and they were using it as an example of a company that doesn't report any adjusted earnings. As they wrote...

If you have never taken in one of FAST's conference calls, we highly recommend you check one out. In a world full of hype and self-promoting companies, CEO Daniel Florness is a candid breath of fresh air. He knows his business and focuses on executing it as well as possible. He isn't afraid to call it like he sees it, and he doesn't try to make the business of distributing fasteners out to be anything more than it is.

They went on to explain that Fastenal "is one of the very few companies left that have not wandered into the murky world of non-GAAP earnings."

Then, my favorite part...

They cited this passage from one of the company's earnings calls, where Florness said (emphasis added)...

I have to say, earlier this morning, I chuckled while reading through, I think, at the moment, Dave Manthey sent out reports early this morning and I really had a kick out of Dave Manthey. I believe it was bullet No. 3, where he commented, while FAST does not report adjusted anything, core gross margin, he went on to explain the impact of the $8 million.

You are absolutely correct, we do not report adjusted anything. We are not an acquisitive company, we're not a manufacturer that's leveraging and talking about EBITDA. We're a distributor and I don't think distributors in our position should be doing that.

Jeff and Bill then went on to contrast Fastenal with food distributor Sysco (SYY), which they said "has one of the longest running and most colorful sets of non-GAAP reconciliations of any company we have followed."

They then questioned the quality of Sysco's most recent $0.04-per-share earnings beat.

I know nothing about Sysco, so I can't comment, but I do know something about Fastenal... and it's hard not to like businesses that play it straight with the way they report their results.

That certainly doesn't mean that all companies that do are good investments, and all that don't are always bad...

But when a CEO says that "we don't report adjusted anything," it's a refreshing reminder, if nothing else, of what public companies used to be.

One other thing before we go...

In another recent post, Jeff and Bill wrote about fraud.

The hook was Gary Weiss' new book on electronic chain Crazy Eddie – which I mentioned in the August 30 Empire Financial Daily – and some of the shenanigans the company used to hide inventory. Jeff and Bill also mentioned the off-balance sheet tricks at Enron. But then they wrote...

Unfortunately, many investors we speak with are under the impression that earnings quality analysis is only useful for uncovering extravagant frauds, which can be exploited through short selling.

That's a great point. The reality is that with so many companies and investors it's often all about meeting or beating quarterly numbers.

But like so much today, there's a hack for that...

Jeff and Bill cite a few garden-variety tricks they look for that can lead to a looming miss, such as:

  • Signs of stretching earnings by a few cents here and there to meet analysts' targets
  • Accelerating cash flow growth through milking short-term working capital
  • Unrealistic assumptions or changes in assumptions behind the values of large assets on the balance sheet
  • Changes in accounting policies or more aggressive accounting assumptions than its peers

I've railed against the "meet/beat" game for decades, but like adjustments – and even adjustments upon adjustments – it's hard to avoid even with stocks and companies you really like... for no other reason than gamesmanship has become the norm.

The trick is figuring out how to win. With stocks, there's no foolproof way... But as Jeff and Bill explain, especially if you are short-term oriented, at least you can improve your odds.

As always, feel free to reach out via e-mail by clicking here. I look forward to hearing from you.


Herb Greenberg
September 20, 2022