Why corporate earnings might be exaggerated

If you’re someone who likes to keep an eye on the stock market and how businesses are performing, chances are you’ve seen plentiful headlines over the years about companies reporting record earnings. But how does that translate to a business’s valuation and stock prices?

Imagine your grandparents bought a house in the 1950s for $10,000. Today, that same house is worth over a million dollars. But when they report their net worth, they still list the house at its original price because that’s what they paid.

You’d immediately sense something is off. That number doesn't reflect reality.

This is, in essence, what many companies do when they report the value of their assets and the profits they generate. It’s not a scam. It’s not a conspiracy. It’s just the result of accounting rules.

And while this might sound like an obscure technicality, it actually changes how we understand corporate performance, stock prices, and long-term investing.

What’s the problem?

Public companies regularly report how much money they’re making, called “earnings,” and investors, analysts, and news headlines rely on these numbers to decide how successful a business is.

But here’s the catch: Those earnings may be based on accounting standards that sometimes use outdated assumptions. One of the biggest culprits is something called historical cost accounting. It’s a rule that says companies must value their assets at what they originally paid for them, not what they’re worth today.

It might sound harmless, but this may lead to companies significantly overstating earnings. The way companies account for wear and tear on those assets (called “depreciation”) ends up being too low. If the cost of replacing a factory has gone up because of inflation, but the depreciation is still based on a decades-old price, then the company’s reported expenses are artificially low, and its earnings look higher than they really are.

Over time, this could create an earnings mirage. Companies may seem more profitable on paper than they are in practice.

This distortion became especially important over the last few years. Following the post-pandemic surge in inflation from 2021–2023, many companies are still operating in a world where the true cost of doing business has increased, yet their accounting systems haven’t caught up. Even now, supply chains, wages, and capital spending remain structurally more expensive than they were just a few years ago. 

When headlines say one thing, but your portfolio manager says another

This gap between accounting and reality helps explain a common source of frustration: why your portfolio manager sometimes doesn’t get excited about the same companies everyone else is talking about.

When the public hears “record earnings,” it sounds like evidence of real-world success. But those earnings may be boosted by accounting quirks that don’t reflect long-term value creation. They might omit the full cost of maintaining infrastructure. They might ignore how much capital a company is burning to stay competitive. Or they might simply ride a temporary wave of demand that’s not sustainable.

Meanwhile, professional analysts are focused on something more fundamental: What are you getting for the price you’re paying? And how repeatable is it?

This tension is especially visible right now in the tech sector. In 2025, artificial intelligence and automation continue to reshape industries. Many companies tied to these trends have seen their stock prices skyrocket. The headlines highlight dazzling innovations and soaring revenues. But beneath the surface, some of these companies are spending enormous amounts to maintain their growth, with thin cash flow and unclear return on capital.

Don’t panic — this isn’t a crisis

At this point, you might be wondering if this changes everything about investing. It doesn’t.

First, it’s important to understand that this isn’t fraud or manipulation. The rules were designed decades ago with good intentions, and every company plays by the same set. This is more of a quirk in the system — a blind spot that analysts and professional investors need to be aware of when interpreting financial statements.

Second, today’s inflation has cooled from its highs, but it left a trail. The cumulative effects are still baked into operating costs and replacement costs. That means the gap between reported and real profitability hasn’t fully closed — and may not for some time.

Still, the lesson holds: Not all profits are created equal, and some reported earnings may look healthier than they truly are.

What you can do (or rather, what we do for you)

The good news is you don’t have to figure all this out on your own.

Understanding where accounting ends and real-world economics begins is part of the work that trusted investment professionals do every day. We read between the lines. We compare free cash flow (the actual cash left over after expenses and investment) to earnings. We adjust for inflationary quirks. And we ask: Is this company really generating lasting value?

That’s why you have experienced analysts and portfolio managers on your side — to interpret, contextualize, and act on information in a way that aligns with your goals, not just with the headlines.

So the next time you see a glowing earnings report or hear someone say, “This company is changing everything,” remember that sometimes numbers are louder than they are true. But with the right team behind you, you don’t have to second-guess the story. We’re here to make sure your investments are guided by more than just what looks impressive in the news.