Income Smoothing and an IPO
You are an analyst for an investment fund that invests in initial public offerings (IPOs).You are looking at the financial statements of two companies, Clark Company and Durfee Company, that plan to go public soon. Net income for the past three years for the two companies has been as follows (in thousands):
|
|
Clark |
Durfee |
|
Year |
Net Income |
Net Income |
|
2005 |
$10,000 |
$17,000 |
|
2006 |
14,000 |
1,000 |
|
2007 |
20,000 |
26,000 |
If both companies issue the same number of shares and if the initial share prices are the same, which of the two companies appears to be a more attractive investment? Explain your reasoning. What alternate sources of data would you look at to find out whether the reported earnings amounts accurately portray the business performance of these two companies over the past three years?