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Strategies & Market Trends : Misleading Earnings Reports -- Ignore unavailable to you. Want to Upgrade?

To: Joe Fang who wrote (32)	10/23/2000 6:07:48 PM
From: ~digs	Read Replies (1) \| Respond to of 53

Smoke, mirrors No doubt a book is already in preparation detailing the most egregious examples. Among the most prevalent is the transformation of pension funds from an expense to a source of profits. Lucent was a particular beneficiary. So were many big industrial companies, such as General Electric and General Motors, which have traditionally provided defined-benefit programmes to their employees. As the stockmarket continued its giddy rise, they booked gains from their pension funds. If a bear market takes hold, such companies must start to contribute to their pension funds again. Many companies have also taken advantage of the bull market to become their own mini mutual funds. Some 30% of Intel’s profits this year have come from its investment portfolio, not from selling semiconductors. Intel is not unique. Given the devastation in the Nasdaq, such profits will in future be far more difficult, if not impossible, to come by. At the beginning of the year Chase Manhattan griped that investors were ignoring its brilliant portfolio of investments. Its latest results, however, were dragged down by that same portfolio of investments. And this time the market isn’t ignoring them: Chase’s shares have fallen by 40% in the past month. Then there is the accounting treatment of purchases. There is, at present, a ding-dong battle between technology companies and accountants over the retention of rules for the treatment of goodwill—the difference between an acquisition price and a company’s book value—following a merger. At the moment, companies can use “pooling”, which does not force them to write off the goodwill. Since, in high-tech companies especially, there is a chasm between the two numbers, this is not a trivial matter. But the credibility of pooling, and the case for giving special treatment to goodwill, dwindles as the giddy market values that once supported these mergers shrink. Of late, the idea of being a boring company in a boring industry with a predictable, if modest, return has become rather attractive. But before high-tech stocks tumbled, such companies were shunned. To pep up their earnings-per-share, many non-technology companies bought back equities and issued lots of debts. That made their return on equity appear particularly strong: since 1991, the return on equity for American companies has doubled, according to Andrew Smithers, who runs an eponymous consultancy. But their return on capital, says Mr Smithers, has risen by a much less impressive 13%. Yet if sales fall and profits shrink, interest bills must still be paid. Perhaps the biggest factor distorting reported profits comes from the treatment of employee stock options, the use of which has grown hugely in recent years. Their attraction is largely that they are not treated as an expense. If its shares rise, a firm must either buy shares in the market or issue new ones. Jack Ciesielski, who publishes the Analyst’s Accounting Observer, estimates that the profits of the companies in Standard & Poor’s 500 are overstated by 6% because of options. In some cases, the results are truly striking. Take, for example, Cisco, America’s favourite growth stock. No doubt the company is growing; the question is whether shareholders are benefiting. According to the firm, its earnings-per-share rose last year from 29 cents to 36 cents. According to James Grant, the author of Grant’s Interest Rate Observer, a newsletter, they rose from 31 cents to 31 cents. Ie, not at all. If all of that were not enough, companies face another challenge. In recent years they have become increasingly adept at “guiding” analysts on profits. New rules instituted by the Securities and Exchange Commission on October 23rd will make this much harder. Inevitably, there will be more doubts about results, and with increased uncertainty usually comes greater volatility. It could be an interesting few weeks. (copied from another board)