Definition

The idea of kitchen sinking is to release bad news at the same time rather than 'spreading' out such announcements over an extended period of time. With all the bad news coming at the same time, companies may also take the chance to take a 'big bath', which is an earnings management technique where earnings are made to look worse than they are. While kitchen sinking is wrong per se, taking a big bath pushes beyond the boundaries of accounting subjectivity and is unethical.

Why now

1. Earnings forecast going to be revised lower anyway so might as well lower expectations more so make future years easier

2. Analysts/market going to write-off 2020 performance and focus on recovery

3. Drive down stock price for management to buy before the recovery; moral hazard due to information asymmetry as management knows things are not as bad as reported

Areas to look out for

1. Write-offs/Impairments/Provisions (banks' loan loss provisions on expected credit loss)

2. Delayed revenue recognition

3. Prepaid expenses

Full impact of Covid19 will take a while to materialize as the second and third order impacts start to come in the coming quarters. When it comes, firms have the opportunity to kitchen sink/take a big bath to lump as much bad news as possible together such that earnings forecasts are lower. During this period, there could be another leg of a downward adjustment for stock prices as the market prices in the new (and lower forecasts). My argument is that this would over-account for the bad news (assuming no huge 2nd wave of Covid-19) and that this would be the best time to enter the market.

Apart from managing earnings, kitchen sinking and taking a Big Bath also can help companies to manage expectations. Generally, company managements would want to ensure that they are able to meet or exceed earnings benchmarks set by analysts' consensus in order to build credibility with capital markets and lower uncertainty about future prospects. From a valuation perspective, the lower the uncertainty/risk associated with the stock, the lower the discounting and the higher the valuation.

Overall, when investors analyze companies, especially during these times, they should be careful about what is presented and evaluate information based on their own expectations of reality. For example, if a retail REIT reports higher yoy profitability, dig deeper into the reasons! I believe that doing their own analysis will help investors to develop their own framework upon which to analyze companies. Happy investing!