Question

When you are interpreting stockholders' equity, what do you need to be aware of and cautious about? Are there areas that would not be exposed in this reporting?

Answer 1

While interpreting the stockholders equity one has to be aware of the classification items as debt or equity in the financial reports. Most often companies classify debt as equity to have better debt equity ratios, show lesser leverage ratios and have a boost to the balance sheet. For example, a preferred stock with a mandatory redemption has to be classified as debt but often classified as equity which in turn results in a better leverage ratio. Another area that is often manipulated is the retained earnings part of the stockholders equity which is often used to distort earnings in order to have a higher ROE. Usually off balance sheet items such as deferred compensation, reserves or write offs that show a higher earnings than the actual.