Adjusted Financials: Boost or Bust for Corporate Bond Analysis?

At a surface level, adjusted company financials might seem indispensable for evaluating corporate bonds. After all, these adjustments can provide a refined view of a company’s financial health, stripped of one-time or non-recurring items. However, for experienced investors, the question warrants a more critical examination. 

Are these adjustments a true reflection of a company’s operational realities, or do they leave the door open for biases that could skew our analysis?

As an analyst, it’s essential to take a balanced, unskewed approach to any topic concerning company financials and bond recommendations. While we are naturally skeptical of adjusted financials, we also appreciate the potential benefits.

Enhanced clarity

In complex corporate environments—marked by mergers, acquisitions, disposals, and any number of one-offs—adjusted financials can offer a streamlined view of a company’s ongoing operations. By removing non-recurring items, these financials can provide a more accurate representation of future performance, which is essential for bondholders focused on cash flow stability and debt servicing capacity.

Improved analytical precision

Adjusted financials often allow for a deeper dive into the company’s core business, filtering out the noise from peripheral activities. For analysts, this means a more precise focus on the most relevant data points, which can lead to more accurate valuations and, consequently, better-informed investment decisions.

Alignment with strategic vision

When management presents adjusted figures, they often accompany these with strategic insights about the company’s future direction. For professional investors, this alignment can be helpful, providing context that might not be obvious in unadjusted financials.

In theory, any revisions that help with a more up-to-date assessment of a company’s financials are welcome. However, when it comes to adjusted financials, we are skeptical for several reasons.

Lack of standardization

The absence of universally accepted guidelines for adjusted financials is a significant concern. Unlike GAAP or IFRS-compliant statements, these adjustments are often subjective, reflecting management’s interpretation of what is ‘non-recurring’ or ‘extraordinary’. This variability can make cross-company comparisons challenging, if not misleading, especially when assessing bond investments where relative value is key.

Potential for earnings management

One of the primary risks of relying on adjusted financials is the potential for management to present an overly optimistic view of the company’s financial health. Moral hazard at play. Management can inflate earnings by excluding certain costs or downplaying risks, thereby obscuring the company’s true financial position. For bond investors, this potential manipulation poses a risk of misjudging the issuer’s creditworthiness.

Reduced transparency

While adjusted company financials might clarify certain operational aspects, they can also obscure a comprehensive view of the company’s financial reality. By focusing too heavily on adjusted numbers, investors might overlook underlying risks, such as deteriorating cash flows or rising debt levels, which are critical in bond valuation.

Regulatory scrutiny/investor skepticism

Frequent deviations from standardized accounting principles can attract regulatory scrutiny, particularly if the adjustments seem aggressive or inconsistent. Moreover, using adjusted financials can lead to skepticism among institutional investors, who may question the validity of the adjustments and, by extension, the company’s transparency and governance practices.

For institutional investors, the challenge lies in balancing the insights offered by adjusted company financials with the inherent risks they present. While these adjustments can provide valuable context, they should not replace a rigorous analysis of the company’s unadjusted financials. At Gimme Credit, we take a cautious approach to revised figures, preferring to base our analysis on actual figures and then make our own revisions where appropriate. We find that this helps to negate the impact of biased adjusted financials, which can be used to support a particular stance.

Adjusted company financials can offer significant advantages in corporate bond analysis, particularly when it comes to understanding a company’s core operations. However, their lack of standardization and potential for manipulation means they must be used judiciously. 

For institutional investors, the key is to maintain a critical perspective, integrating adjusted company figures with a thorough analysis of unadjusted financials to arrive at a balanced and informed investment decision. By doing so, investors can mitigate the risks of bias and maintain the integrity of their portfolio management strategies.

If you would like to know more about our research process, please get in touch, and we can discuss the benefits of our broader approach to analysis.