The views expressed here are those of the author, the publisher of Income Securities Advisor.
By Marty Fridson
NEW YORK, Dec 23 (Reuters) - It is generally not a good sign when an accounting issue becomes a hot topic on Wall Street. That’s why recent chatter about U.S. technology giants’ depreciation schedules should make investors wary heading into 2026.
Ordinarily, matters debated by those who prepare corporate financial statements are too esoteric – and, frankly, too dull – to interest equity investors.
However, at the beginning of this century, accounting made its way into the headlines after Enron, WorldCom, and Adelphia Communications, among others, were shown to be using deceptive practices.
These companies swiftly migrated from seemingly fabulous success to bankruptcy, with widespread market repercussions. For a time, investors wondered whether they could rely on any company’s representation of its profitability and financial condition.
This egregious accounting malpractice – and, indeed, criminal fraud – led to major changes, most notably the Sarbanes-Oxley Act. It made outright fakery largely a thing of the past among U.S. public companies.
Investors cannot afford to let down their guard, however.
Misleading yet legal financial reporting continues to represent a significant risk to markets. If the reported earnings of a company are revealed to be detached from the underlying economic reality, the firm’s share price could tumble. And if the company is big enough, it could potentially take the broader U.S. equity market down with it.
A BIG WORRY
In this context, the current controversy involving depreciation schedules at big tech firms is worrying.
Take Nvidia NVDA.O, the $4 trillion-plus maker of semiconductor chips. Michael Burry, the investor whose successful bets against the U.S. housing market in 2008 were recounted in the movie "The Big Short," contends that the AI juggernaut is overestimating its profitability by taking too many years to write off the cost of producing its semiconductors. The longer the depreciation period, the lower the annual charge against earnings.
Burry argues that the chips will lose value due to technological advances more quickly than assumed by the company’s depreciation schedules. Nvidia bulls, on the other hand, suggest the lengthy period simply reflects how long the company’s chips will last in terms of wear and tear.
Nvidia is not the only tech company whose earnings are currently under scrutiny due to depreciation practices. Burry has pointed the finger at cloud computing giant Oracle ORCL.N, for one. And other "Magnificent Seven" companies, including Alphabet GOOGL.O, Amazon AMZN.O, Meta META.O, and Microsoft MSFT.O, have also been extending the “assumed useful lives” of some major assets since 2020 as their capex spending has skyrocketed.
In addition, there is some evidence to suggest that IBM IBM.N is getting in on the game. Big Blue’s total depreciation expense dropped from $4.2 billion in 2020 to $2.2 billion in 2024, while revenues increased from $52.3 billion to $62.8 billion, according to Stock Analysis on Net, a research provider that analyzes large U.S. companies’ financial statements.
Asset disposals could also have contributed to IBM’s change, of course, along with other tweaks to depreciation policies, but extending assets’ assumed useful lives could be contributing as well.
TEMPEST IN A TAX FORM
An important point to remember about corporations’ depreciation schedules is their total lack of importance in creating shareholder value.
These accounting techniques matter for tax purposes, but the financial statements companies file with the Internal Revenue Service are distinct from those they provide to investors.
In firms’ annual reports, depreciation expense is merely an accounting entry. Reducing it through a change in assumptions does not increase cash flow or, by extension, the enterprise’s economic value. It should thus be unsurprising that stock prices tend not to rise in response to this kind of cosmetic action.
Why, then, do companies bother playing around with depreciation schedules?
It was more understandable back in the 1980s and 1990s when CEOs’ compensation was often tied to reported earnings per share. But today most public companies compensate their CEOs on the basis of share price rather than EPS.
Perhaps, these accounting techniques are a way to reduce seemingly “excessive” earnings multiples, something tech executives have had to justify repeatedly in recent years.
Information technology stocks are currently trading with an average price-to-earnings (P/E) ratio of 36, based on consensus analyst estimates, as of December 18, according to Bloomberg, compared with only 25 for the S&P 500 as a whole.
Increasing the denominator makes the P/E ratio look less lofty and may thus make life a little easier for CEOs, chief financial officers, and investor relations officers at highly valued tech giants.
But the proliferation of such actions does not help investors seeking to determine whether stocks are fairly priced.
To be clear, there is no indication of any fraudulent accounting practices in big tech today.
However, these stocks are priced for perfection, and if the depreciation debate intensifies, investors could begin reassessing company earnings. With markets already jumpy about any perceived “bad news,” this might be enough to kick off a painful correction.
(The views expressed here are those of Marty Fridson, the publisher of Income Securities Advisor. He is a past governor of the CFA Institute, consultant to the Federal Reserve Board of Governors, and Special Assistant to the Director for Deferred Compensation, Office of Management and the Budget, The City of New York.)
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(Writing by Marty Fridson; Editing by Anna Szymanski.)
((anna.szymanski@thomsonreuters.com))
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