The degree to which reported earnings accurately reflect the true economic performance and cash-generating capacity of a business.
Deeper Explanation
High-quality earnings are: cash-backed (FCF closely tracks net income), consistently generated (not dependent on one-time items), and transparently reported (accounting choices are conservative rather than aggressive). Red flags for low earnings quality include: large and growing accruals (the difference between earnings and cash flow), frequent use of "adjusted" or "non-GAAP" metrics that exclude recurring costs, aggressive revenue recognition, and rapid growth in accounts receivable or inventory relative to sales. Sloan's accrual anomaly — published research showing that high-accrual companies systematically underperform — is one of the most replicated findings in financial economics.
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