See that good looking dude on the left? He's got FAR BETTER THINGS to do than conduct Freepathons! Come on, let's get this thing over with.
Posted on 07/14/2003 8:10:55 PM PDT by sourcery
CORPORATE earnings season got off to its official start last week, and the second-quarter results had better be good. If they are not, the big move in stocks of the last few months will have less footing than rational investors require.
But even if many companies report decent numbers, investors should not break out the Dom Pérignon. Because the quality of earnings has declined so significantly among the nation's largest companies ? those in the Standard & Poor's 500-stock index ? it is not hyperbolic to advise investors to view every profit report with suspicion.
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David Bianco, accounting analyst at UBS in New York, said: "The quality of earnings for the S.& P. 500, from an accounting standpoint, is the worst it has been in more than a decade." And he has done the work to prove it.
The slide is largely the result of aggressive accounting practices in three areas, he said. First are so-called special charges, which companies say are one-time events from re-structurings or asset impairments, but which may actually include recurring operational costs that should be deducted from revenue. Second is the choice many companies have made not to subtract the costs of stock options from their results, and finally, there are those rosy pension assumptions ? inflating pension earnings or masking pension costs ? that improve corporate earnings.
Taken together, earnings at many companies are not what many investors think they are, Mr. Bianco said. As a result, these company shares sport a higher cost, in the form of a price-earnings ratio, than investors believe.
He analyzed results at each of the S.& P. 500 companies over the last 11 years, viewing earnings and accounting practices over an entire economic cycle. Then, he adjusted the companies' reported earnings for special charges, stock-option grants and overly rosy pension assumptions. What he found was that in 1991, the adjusted earnings were roughly 18 percent less than those the companies reported to shareholders: $15.91 a share versus $19.50 a share.
Shifting to 2002, the difference grows vast: earnings adjusted for the funny stuff were 41 percent less than the profits reported to investors.
So while investors may have thought that they were paying roughly 19 times the earnings of S.& P. companies to own the index last year, they were really paying almost 25 times profits after adjustments for the three items.
At individual companies the numbers become even more troubling. Texas Instruments, which analysts expect to earn roughly 35 cents a share this year, would earn 10 cents a share if Mr. Bianco's adjustments were made. That increases its price-earnings ratio from 54 to 188, based on Friday's close. And at eBay, Mr. Bianco figures that while analysts forecast its profit at $1.46 a share, the figure would drop to 57 cents this year if adjusted by his method. That ramps up eBay's price-earnings ratio from 77 to 198.
ALTHOUGH Mr. Bianco can only estimate what the companies will report in special charges and the like, he has based his assumptions on historical norms.
"We've all been waiting for the day when people will be forced to acknowledge quality-of-earnings problems," Mr. Bianco said. "Some of it seems to be occurring." More companies are expensing the costs of stock options, and regulators are pushing companies to justify special charges. "If earnings are overstated because of these things," he said, and new rules force changes, "it's going to be more difficult for earnings to grow from these levels."
In other words, the great stock market bubble lives on.
See that good looking dude on the left? He's got FAR BETTER THINGS to do than conduct Freepathons! Come on, let's get this thing over with.
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