Maybe the CEO Was on to Something...

It's rare that I laugh out loud when I'm listening to an earnings call...

In general, these quarterly calls are dull affairs. For every time you catch something like the Lehman Brothers CFO swearing on the company's third-quarter earnings call in 2008 – and management having to re-edit the audio afterward to remove the profanity – you get thousands that will put you to sleep.

So I perked up when I was listening to audio of the Cleveland-Cliffs (CLF) third-quarter earnings call last October...

You guys should resign for your lack of knowledge of things.

That's how the CEO of Cleveland-Cliffs, Lourenco Goncalves, answered a question during the call. And he didn't stop there...

You don't understand our business – you don't understand your own business...

You are a disaster. You are an embarrassment to your banks.

There was more, but you get the picture... Goncalves was on the attack against the Wall Street analysts covering his company. He believed they were too pessimistic about Cleveland-Cliffs. He was convinced their analysis led to inaccurate conclusions.

His rant eventually ended up all over the news. This story is still on Google search results when you look up just his name. Not the most professional behavior from the CFO of a $2 billion company...

But what if I told you he was right?

At least, he was half right. We don't want to say those analysts should resign. And we aren't saying they are an embarrassment. We are saying sell-side analysts definitely still don't understand the Cleveland-Cliffs business.

This is because those analysts are using as-reported financials. The real numbers show us the twist in this story – and it would even take Goncalves by surprise...

Generally accepted accounting principles ("GAAP") suffer from a host of distortions around things like excess cash, stock option expense, and replacement costs for property, plant, and equipment ("PP&E").

As you know by now, my team and I specialize in "Uniform Accounting" – a more reliable way of looking at companies than the GAAP and International Financial Reporting Standards ("IFRS") accounting policies... policies that distort the way we think about companies like Cleveland-Cliffs.

Once we make the appropriate adjustments, it's clear that the sell-side analysts don't know what they're looking at.

The only problem for Goncalves is they aren't too negative – they're too positive! Take a look (you can click the image for a closer view)...

The two panels above explain Cleveland-Cliffs' historical corporate performance levels in terms of return on assets ("ROA") and asset growth. We're focused on the blue bars – which are the real numbers – compared to the as-reported numbers in orange.

Looking at this, Goncalves was right... in a way. Analysts using as-reported data have no idea how badly Cleveland-Cliffs has done recently.

Specifically, those "embarrassing" investors might have thought Cleveland-Cliffs was improving its profitability from 2016 through 2018. As-reported ROA rose to 13% in 2018, up from lows of 3% in 2015. However, the real numbers show something different... Adjusted ROA is actually down since 2015, from 13% to 5%. It's been around 5% since 2016.

Because of the accounting, investors really didn't understand how poorly Cleveland-Cliffs was performing. But since Goncalves' explosion last year, investors appear to have caught on... The stock is down more than 40% since the date of the call, as of yesterday's close.

Cleveland-Cliffs might not be done falling, though... because GAAP numbers aren't just getting the returns wrong for the business – they're also getting the valuations wrong.

Based on a GAAP price-to-earnings (P/E) ratio of just 4.7 – an incredibly low valuation – investors may think this company has finally fallen so far it can't fall further.

But when you clean up the accounting and look at the real numbers, the adjusted P/E ratio is actually at 13.1 right now.

CLF is about 170% more expensive than investors realize! And the chart below shows that this isn't a new phenomenon, either...

Goncalves was right – investors don't understand his company. But with Uniform Accounting, the insights start to become clear.

When GAAP has the power to mislead those in charge to think they have a good, cheap business, how is the average investor supposed to keep up?

Regards,

Joel Litman

Editor's note: Joel wants to give you a huge advantage over the Wall Street "pros"... It's why he built a tool to help investors see the hidden earnings of almost any stock. Recently, he teamed up with Porter Stansberry to walk through exactly how it can help you spot investments poised to skyrocket... or crash. Best of all, he revealed an overlooked stock that could soar 500% from here. Watch his demonstration before it goes offline...

Further Reading

Most investors ignore one simple metric when they buy a business. And as Joel explains, it's also a great way to gauge what's in store for today's bull market... if you're using the right numbers. Get the details right here.

"You've probably heard a lot of worries about slowing earnings growth," Joel says. "Everyone's wondering when the bull market will finally grind to a halt." Investors following the widely accepted numbers are nervous today... but by using the right metrics, you can see what's really going on. Learn more here.

Market Notes
A 'BORING' FOOD DISTRIBUTOR THAT HAS QUIETLY DOUBLED

Today’s chart proves a “boring” business can deliver market-beating returns…

When investors think about food delivery, it’s probably Grubhub (GRUB) or Uber Technologies’ (UBER) Uber Eats. These spiffy mobile apps let folks get food delivered to their homes. But Uber keeps losing money… and GRUB shares are down almost 65% from their peak today. Contrast that with this “boring” food company…

Sysco (SYY) is a $40 billion food distributor. It delivers food and related supplies to restaurants, hotels, schools, and hospitals. That’s not as novel or exciting as an app that summons tacos or burgers to your house… But it’s a strong business with big, steady profits. Sysco made $11.4 billion in gross profit over the past year, up 3% from the year before.

SYY shares have more than doubled over the past five years, and they recently hit a new all-time high. Over the same period, Sysco shareholders have also enjoyed a 34% jump in quarterly dividend payments. While flashy tech companies soar and crash, “boring” companies can quietly bring outsized gains…