Final answer:
Low-quality earnings are profits that may give a misleading view of a company's financial health, including one-time gains, pro forma earnings, and income shifting.
Step-by-step explanation:
Low-quality earnings refer to profits that are considered unsustainable or not indicative of a company's true financial health. These earnings can distort an investor's understanding of a company's performance and future profitability. Here are three examples of low-quality earnings items:
- One-Time Gains: These are earnings that arise from events that are not part of a company's regular, core operations. Examples can include profits from the sale of assets, insurance settlements, or legal disputes. They are not expected to occur regularly and can inflate earnings in the short term.
- Pro Forma Earnings: Companies sometimes report pro forma earnings, which exclude certain costs or expenses considered non-recurring. However, if these costs occur more regularly than the company indicates, relying on pro forma earnings can lead to a distorted view of profitability.
- Income Shifting: This accounting technique involves shifting income from future periods into the current period, or deferring expenses into the future. This can temporarily increase earnings, making the company appear more profitable than it actually is in the long term.
These low-quality earnings metrics can be misleading to investors, and it is important to analyze them carefully to gain a true understanding of a company's financial condition.