There’s a big con going on in the stock market right now. Company earnings are falling and have been for some time but CEOs and CFOs are doing everything in their power to distract investors from this fact and tell a completely different story. The gap between earnings’ reality and the fantasy companies would have you believe is the now widest since 2008.

Why earnings are even worse than companies have been saying – Heard on the Street https://t.co/WYEM3FXo0x pic.twitter.com/Z5ZndhtdZr

— WSJ Markets (@WSJmarkets) February 24, 2016

A big part of the “pro-forma” adjustments to income that company managements like to make are so-called “one time” items like acquisition or restructuring costs. The trouble is there are a number of companies whose “one time” items recur every single quarter.

“@AnalystWire: Aegis Maintains Buy on Valeant ($VRX); One-Time Items Don’t Reflect True Operations http://t.co/ACL4Gki4UD”

— Darcy Keith (@eyeonequities) October 31, 2013

For example, Valeant Pharmaceuticals (VRX) is what we would call a “serial acquirer.” Over the past several years they have rolled up so many other pharmaceutical companies that they have essentially made M&A their primary business. Yet they insist on treating the costs related to these activities as “one time” items that investors should ignore. Clearly in the case of Valeant, investors who have followed management’s lead here have been sold a bill of goods.

Valeant is to health care what New Century was to home mortgages in 2006 https://t.co/37pnfMNbML by @Peter_Atwater

— Jesse Felder (@jessefelder) November 12, 2015

Another popular adjustment managements like to make to earnings is to remove the cost of stock option grants. Perhaps the best example of this is Salesforce.com (CRM), who reported earnings last night. According to the rules of GAAP, the company lost $26 million last quarter. When you remove the cost of option grants ($159 million) along with various other items, the company would have you believe it actually “earned” $130 million.

$CRM
GAAP EPS $0.00
NON-GAAP EPS $0.22

* non-gaap makes $0.22 Stock-based expense adjustment.

not kidding. they do this every quarter.

— Bob Brinker (@BobBrinker) February 24, 2016

In other words, all of the income the company made last quarter and then some was given to employees in the form of equity. Salesforce would like you to believe this really isn’t a cost of doing business. But the FASB, Charlie Munger and plain old common sense say different.

Now here’s where the disparity between fantasy and reality gets interesting. There are some analysts and pundits who argue that investors should take companies at the word. Based on these “pro forma” earnings numbers they would have you believe that stocks are fairly valued today.

Stocks are fairly valued when compared with U.S. earnings, investor Rich Bernstein says. See my Chart of the Day. http://t.co/J8ahHcTuyM

— David Wilson (@TheOneDave) April 10, 2015

However, it’s very important to note that earnings before the effects of buybacks and management-fudged “pro forma” adjustments have essentially gone nowhere since 2012 even while stock prices have soared 50%. In this light it’s very difficult to argue stocks are anywhere close to “fairly valued” relative to earnings.

Every time the market rallies, remember that prices ALWAYS revert back to long term fundamentals. ALWAYS pic.twitter.com/GgSlP0Qum6

— JP Compson (@JPCompson) February 24, 2016

Perhaps an even better way to get a handle on valuations is simply to look at price-to-sales ratios, as companies can’t really fudge their sales numbers. Just take a gander at that median price-to-sales ratio in the chart below and you’ll start to understand just how big of a deal this earnings con has now become (I should note that record-high profit margins are also responsible for some of this discrepancy between sales-based valuations and earnings-based ones, but that’s an entirely separate issue).

Ned worries long-term valuation investors will not come back to market until price/sales ratios ease. pic.twitter.com/raw9ZdRTZk

— Ned Davis Research (@NDR_Research) February 17, 2016

Finally, it may be enough to simply note that the last two times the gap between GAAP and non-GAAP earnings was as wide as it is today was during the last two recessions. During an expansion in economic activity companies don’t need to resort to these sorts of tricks. During recessions however, when earnings begin to crater the temptation to try to do what they’re doing today is probably just too great to resist.

Right now they’re clearly feeling that temptation once again, and to a great degree. That, in itself, may be a good sign we are entering a new recession, if not already in the midst of one. This would also potentially confirm some of the other data out there signaling weakness in the economy right now.

Industrial Production Is Leaving Little Doubt The Economy Is Already In Dire Condition https://t.co/OIIQToGsf3 pic.twitter.com/MI2vX7w2kF

— Jesse Felder (@jessefelder) February 18, 2016

It appears as if analysts are now coming to that very conclusion as well. Forward EBITDA for the S&P 500 is currently falling at a rate we haven’t seen maybe ever. And this also stands in stark contrast to the earnings story companies would currently have you believe.

Those 12-mth 18-mth forward S&P EBITDA revisions are really something pic.twitter.com/QfcKfKKVJc

— Eric Burroughs (@ericbeebo) February 25, 2016

So you can buy what companies are selling today and believe stocks are fairly valued relative to earnings, or you can see through the charade and understand that this is not a new game they’re playing. They do it every cycle and investors get burned every time.