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There is much that stands in the way of making accurate earnings forecasts. Not only are companies in the line of fire of thousands of essentially unpredictable events that may change their fortunes for the better or for worse every day, but sometimes the company itself may use a form of creative accounting to their advantage.

Harvard economist Richard Zeckhauser, in a paper coauthored with Jay Patel of Boston University and Francois Degeorge of the HEC School of Management in Paris ("Earnings Manipulation Exceeds Thresholds", Working Paper, 1997) found evidence of what they call the "Big Bath Theory".

This is creative accounting at its finest. Since stock analysts place a high premium on companies with steady growth in earnings, this is a way of appearing to achieve that. The idea is to report a steadily increasing growth in earnings year after year, regardless of the actual state of the company.

Following an extended period of time doing this, with their stock trading at a good price and the market applauding management, they decide to take a massive one-off hit to their earnings to set things right.

Not only do they write off massive capital losses and expenditures, but declare a heap of bad debts as well as write off other assets, often going overboard and writing off more than is necessary perhaps, to take all their lumps in one swift hit.

Following this collapse, the company is able to go back to dishing up the kind of steady, predictable growth that the market is accustomed to from this stock. Hopefully the problems are soon forgotten as a one-off extraordinary expense, and all is forgiven, at which stage the company can go back to being a darling of the stock market with steady growth in earnings and an excellent track record.