Earnings are an opinion. Cash is a fact.

In a market that moves trillions every quarter on one number, almost nobody asks whether the number is real.

In 1957, an economist named Joseph Berliner published a book about Soviet factory managers.

He’d spent the previous decade interviewing emigrants who had run plants under the central planning system. What he found was a system addicted to a single number. Factories were graded on output (tons of steel, square meters of glass, units of whatever...) and nothing else mattered.

So the managers gamed the number. Nail plants made absurdly long nails because the target was tonnage. Glass factories made sheets so thin they shattered when you looked at them, because they were graded on square meters.

The quotas were met every quarter. The economy fell apart.

Wall Street has a single number too.

The bottom line. The earnings.

CNBC puts a green ticker next to it, and trillions of dollars in market cap moves on the result.

Sloan ran Berliner's experiment on Wall Street

Richard Sloan asked the same question Berliner asked, but about earnings. He was an accounting professor, not a stock picker. He wanted to know whether the market correctly priced the quality of earnings or just reacted to the headline.

So he ran the test. He sorted thirty years of US stocks by how much of their earnings came from cash versus accruals (revenue you’ve booked but haven’t collected, expenses spread across periods, inventory you’ve built up that hasn’t sold).

He bought the cash-heavy decile. Shorted the accrual-heavy decile.

The spread was 10.4%. Per year. Positive in twenty-eight of the thirty years he studied.

A dollar of cash earnings this year usually produces 85 cents next year. A dollar of accrual earnings produces only 76 cents — and the decay accelerates after year two.

The market prices both as if they're the same. So companies whose earnings are mostly accruals get priced as if those accruals will last.

They don't. And the gap closes through the stock price.

A green ticker, a hollow quarter

Stellantis. The owner of Chrysler, Jeep, Peugeot, Fiat.

In late 2023, its reported numbers looked impressive. Revenue growth in the 82nd percentile of its sector. Net income growth in the 100th. The kind of profile that gets a green ticker.

The cash flow told a different story. The Safety pillar in MonkScore sat at 31 out of 100. The cash-to-net-income component sat at 37. The overall MonkScore was 2 out of 100.

Wall Street loved the numbers. Eighteen months later, the stock had lost more than half its value. Today it's down 70% from peak.

Sloan would have called this. MonkScore did — and still does. Today: 0/100.

Three lines, five minutes

The check that comes out of Sloan’s paper takes five minutes per stock:

1. Find operating income after depreciation on the income statement.
2. Find cash flow from operations on the cash flow statement.
3. Compare them. If cash is materially below income — and especially if the gap has been widening — the earnings are running on accruals.

That doesn’t make a company a fraud. High-growth firms legitimately have high accruals because they’re building inventory and extending credit. The point is that the market underprices the risk of those accruals not persisting.

It pays to keep score.

That's part of why MonkScore looks the way it does.

The Safety pillar pairs Sloan's accruals work with Campbell-Hilscher-Szilagyi's distress dynamics and a fundamental-deceleration check. Mispriced earnings show up through more than one channel.

If you want to see what the Safety pillar flags on a stock you own, app.monk.st will pull it up. Search the ticker, scroll to Safety. Works on every plan, including the free 14-day Premium trial.

Find the gap. Close the loop.

— Alberto.