Opinion

When A Loss Isn't Really A Loss

Baruch Lev

By Feng Gu and Baruch Lev

By Feng Gu and Baruch Lev

This is earnings season, and companies reporting losses are a daily occurrence. But even prior to COVID-19, losses proliferated. In 2019, a full 46% of U.S. public companies reported an annual loss, and among high-tech and science-based enterprises losses reached an epidemic level of 70%. And this in the booming pre-Covid economy. A loss creates serious hardship for investors: Popular market multiples, like the price-earning (PE) ratio, are meaningless, and predicting future earnings, or cash flows and their growth from a starting point of a loss is highly problematic. So it’s very important to ask whether all those accounting-based reported losses are really losses. The short answer: an emphatic no!

Consider the software company DocuSign, Inc. (DOCU), which reported a $208 million loss for 2019. DocuSign’s earnings, like those of all U.S. listed companies, were computed after subtracting from revenues R&D ($186 million in 2019) and sales, general and administrative (SG&A) expenses of $727 million. SG&A includes many intangible investments, such as IT, brand enhancement, employee training, etc. These intangible investments plus R&D are, in the 21st century, the main drivers of corporate growth. Only a highly deficient, industrial-era accounting system (U.S. GAAP) can consider such investment to be regular expenses, like interest or wages.

When we capitalize R&D and other intangibles in SG&A (that is, consider these assets, rather than expenses), and subtract from revenues the amortization of the capitalized intangible investments — akin to the accounting treatment of, say, property, plant & equipment — DocuSign’s 2019 accounting loss of $208 million transforms to a profit of $97 million. (Our amortization rate of annual past R&D expenses was 30%, based on the estimated life of acquired software, which usually is three to five years. As for SG&A, we added to earnings one-third of annual SG&A expenses, which is approximately the part of these expenses representing intangibles.)

Read the full Seeking Alpha article.

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Baruch Lev is the Philip Bardes Professor of Accounting and Finance.