Explain the signs that indicate earnings quality

Earnings are of higher quality when they are recurring, backed by cash and not propped up by estimates. Warning signs include profit growth driven by non-recurring gains, a large and rising gap between net income and operating cash flow, frequent restructuring charges treated as one-offs, and a pattern of just meeting or beating analysts' forecasts. Restatements, enforcement actions and changes in auditor are serious signals. Revenue recognised through bill-and-hold deals or gross rather than net reporting deserves scrutiny, as do expenses pushed into capitalised costs. The analyst should separate core earnings from items that will not repeat. The trap is treating a smooth earnings record as high quality, when smoothing itself can reflect management of reserves.