A study of nearly 400 chief financial officers conducted by a group of U.S. academics (Financial Analysts Journal, Number 1, 2016) concluded that 20% of companies intentionally misrepresent their earnings even while sticking to generally accepted accounting practices. No wonder investors have such a hard time figuring out how companies are really doing.

According to the study, C-suite executives disguise the real performance of their business mainly to influence the share price. This is not surprising given the punishment levied on stock prices when profits dip below market expectations.

A second reason is that management compensation is often tied to the financial performance of the business or to the share price. So it’s no surprise company executives have a strong incentive to skew earnings to enrich their personal bank accounts.

Given these shenanigans, which red flags are a crucial sign that a company is misrepresenting its profits? The chief financial officers were again kind enough to provide a list of potential red flags, from which we have picked four that we come across the most when analyzing financial statements:

1) Accounting profits move higher but cash flow from operations move lower —and it continues for a number of quarters.

2) Large and frequent one-time or special items including restructuring charges and write-downs that are excluded from “adjusted earnings” at management’s discretion.

3) A smooth pattern of earnings that consistently meet or beat expectations.

4) High turnover of executives or a sudden change in top management or financial executives.

Companies with financial reports that regularly include some of these characteristics should prompt investors to ask serious questions or just stop investing in these companies. Because financial statements of large public companies are enormously complicated documents, even professional analysts have the unenviable task of unearthing how these companies really did.

But it is impossible for companies to fudge the payment of cash dividends. The picture for income investors is therefore less complicated. Dividends are a key focus for Canadian Edge, and  to determine whether a company will be able to sustain and grow dividends over time, we mainly look for these four things.

A track record of consistent and growing dividend payments. We like to see a history of at least five years and preferably much longer. If the company has missed or lowered a payment in the past, we need to understand why it happened and determine whether it could happen again.

A rock solid balance sheet. Does the company carry high levels of debt? We want to avoid the risk that the company won’t have enough cash to pay the dividend after the debt has been serviced. Acceptable debt levels also depend on the cyclicality of the underlying business. Companies with stable income streams can afford to take on more debt, especially when interest rates are low. More cyclical companies should hold less debt.

A payout ratio with wiggle room. The best-designed business strategies can quickly unravel, leaving dividend payments at risk. So we want companies that can sustain their dividend payments when times get tough, and here we focus on how much free cash flow a company pays out rather than the nebulous notion of accounting profit. For cyclical companies we want to see a low payout ratio, but for businesses with more stable profits, a higher payout ratio is acceptable.

Prospects to grow the dividend faster than the rate of inflation. A company that can’t grow its dividend is unlikely to provide an attractive total rate of return (dividend plus capital appreciation). This is a key forward-looking aspect of our assessment, and we want to be comfortable with the strategy of the business and other factors such as proper accounting treatment.

One of the CFOs interviewed for the academic study pointed out that it’s difficult for analysts to spot a dishonest C-suite just from public information.

That’s why we prefer to focus on the simple but powerful message that is evident from dividend announcements, as well as the various features that support those ongoing payments, rather than try to decipher the often confusing and possibly misleading quarterly earnings statements.