"This is a classic arbitrage between accounting and cash flow, " says Warburg Pincus Managing Director David Coulter.

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Gas exploration companies like Chesapeake (CHK) or SandRidge (SD) have never been cash flow positive but often report positive accounting earnings.

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Even better is free cash flow, which helps avoid other accounting distortions.

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Our model, which tracks performance back to 1998, shows 2010 as the most profitable year ever in terms of accounting earnings, economic earnings, and free cash flow.

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Much of the gas being produced, when you add in all the expenses including building gathering systems, purification plants, and accounting for the bad wells, lose money on a pure cash flow basis.

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Accounting ignores these critical details while finance incorporates them by using cash flow metrics rather than earnings metrics and a cost of capital measure that reflects current interest rates plus a component for a company's overall riskiness.

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