WSJ - Monday: Some CPQ excerpts in a long article about the definition and status of corporate profits. For those who want to read the whole article I have attached it below the CPQ excerpts.
"Despite trouble at Compaq Computer, which dumped its chief executive as the company struggled to deal with inventory problems, most computer makers did well as sales of PCs and powerful computer servers continued to accelerate. Computer manufacturers reported that net income rose 55% from the previous year, while office-equipment makers saw net income jump 102%, although both of those numbers reflect very easy comparisons with last year, when many technology companies were mired in excess inventory.
Some analysts anticipate a slowdown in computer sales when companies ease back on purchases of new systems as they complete preparations for the year-2000 computer problem. But others point out that the real strength in computers has been in home machines anyway, sales of which haven't accelerated because of Y2K and so shouldn't slow down either. "Tech is alive and well," Morgan Stanley Dean Witter's Mr. Rauscher says.
More PC sales in the first quarter brought more sales of software to run on the new machines. Software makers reported net income was up 34%.................
Earnings at the nation's computer makers mostly roared ahead, despite serious setbacks at Compaq and some warnings that the year-2000 problem could harm sales later in the year. International Business Machines raced past analysts' expectation with a 42% gain in earnings, powered by a surprising 17% increase in hardware sales. Dell Computer continued to outpace competitors with direct sales of PCs to businesses and consumers. Sun Microsystems is still benefiting from the explosive growth of the Internet, posting a 13% gain in profit as its revenues from sales of powerful server computers surged."
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May 3, 1999
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Latest Profit Data Stir Old Debate
Between Net and Operating Income
By DARREN MCDERMOTT
Staff Reporter of THE WALL STREET JOURNAL
NEW YORK -- It's getting harder than ever to measure corporate performance.
Just look at the latest profit figures for the first quarter. The Wall Street Journal's official tabulation for 665 of the companies that make up the U.S. component of the Dow Jones Global Indexes shows that net income declined 4%, but operating income -- which excludes write-offs and other one-time items -- rose a strong 9.6% compared with the 1998 first quarter.
This difference is even wider than in the fourth quarter, when net income rose 1% in the Journal's final survey of the quarter, and operating income, according to calculations made for the Journal by First Call, rose a healthier 4.6%.
Whether corporate performance should be measured by net income or operating income has been the subject of debate on Wall Street for years. Lately, the balance has shifted heavily toward favoring operating income -- a trend that companies are trying to encourage, as it can enable them to escape being penalized for hefty write-offs and one-time items that they say obscure measurement of continuing performance. In the latest quarter, for example, Ford Motor's net income declined 89%, but its income would have risen 20% if a one-time $15.96 billion gain from the year-earlier first quarter had been excluded from the calculation. The gain came mainly from the spinoff of Ford's Associates finance unit.
Industry Groups
Basic Materials
Energy
Industrial
Consumer, Cyclical
Consumer, Noncyclical
Technology
Financial Services
Utilities
Conglomerates
But not everyone agrees that focusing on operating income is the way to go. And not all analysts define operating income the same way; there is no accounting standard for the measure. In addition, "write-offs matter," Merrill Lynch equity strategist Richard Bernstein says. "They speak to the volatility of earnings, and that should matter to investors." In fact, it does matter to investors, Mr. Bernstein argues. Analysts may be using operating income to measure profits, but Mr. Bernstein concludes that, whether they know it or not, investors buy and sell stocks using net income; the market rewards companies that don't take write-offs, his research has found.
For most analysts, however, operating income is what counts. And, conveniently, operating income was great. "I think the first quarter was sensational," says Larry Rice, chief investment officer at Josephthal & Co.
First-quarter 1999 profits for 665 companies.
Industry-by-industry first-quarter earnings, with percentage changes from a year ago.
Canadian corporate performance.
Whether profits are strong or not, what everyone wants to know is whether they will continue to rise. Many analysts say they will. "We think the earnings recession of 1997-98 is over," says an ebullient Douglas R. Cliggott, U.S. equity strategist at J.P. Morgan Securities. He argues that the world's economies, so battered by events last year, have started on a process of healing that will only improve profits for U.S. companies with international exposure as the year goes on.
Analysts who believe that corporate profits are tied more closely to domestic affairs are even more enthusiastic. "Our theme is one of consumers driving things forward from here," says Brian Rauscher, a Morgan Stanley Dean Witter strategist.
First-quarter performance also looked strong by other measures. For example, operating income for the 86% of companies in the Standard & Poor's 500, the most widely watched yardstick on Wall Street, increased 10%, according to First Call.
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Sector Operating Income First quarter, in billions, excludes one-time and extraordinary items:
1999 1998
Basic Materials $2.72 $3.38
Energy 2.95 5.51
Industrial 5.71 5.53
Consumer, Cyclical 15.09 13.15
Consumer, Noncyclical 16.87 15.55
Technology 13.61 10.18
Financial Services 24.60 21.72
Utilities 11.54 9.99
Conglomerates 2.33 2.02
TOTAL 95.42 87.03
Source: First Call Corp.
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And operating income has blown past analysts' expectations to a degree rarely seen. The results exceeded mean analysts' expectations by 4.9% at the time the companies released them. Of course, analysts commonly lower their estimates as reporting day nears. But actual operating income beat by 4.8% the estimates made 30 days before the figures were reported.
The first quarter's gain in operating income was due in part to greater stability, though not yet recovery, in many of these companies' overseas sales markets as well as international financial markets. A host of other factors, meanwhile, combined to create the best domestic business environment many industries have seen in years.
Consumers were spending freely; interest rates were low, and so was inflation; productivity was rising, and so was the stock market; workers, in general, stayed on the job instead of striking as they did at General Motors last year.
All that meant most companies performed well in the first quarter -- not only relative to analysts' expectations, which are easily and often manipulated by the companies themselves, but also compared with their performance a year earlier. "The bottom line," says First Call Research Director Chuck Hill, "is we're doing very well relative to expectations, and we're going to have a good quarter in year-on-year growth as well."
Mr. Hill traces the rebound in operating income to the fourth quarter of last year, when by his estimates operating income for companies that make up the Standard & Poor's 500 rose 6% -- a reversal of the third quarter's 3% drop, but still below the average of about 7% in recent decades. (Other companies that track corporate earnings reported lower net income or even losses, because of differences in how they factor in changes in accounting rules and in the year-to-year constituents of the S&P 500 index.)
The first-quarter corporate-profit picture was simply an extension of the previous quarter's trends, Mr. Hill says: Strong sectors such as technology performed even better than they did in the fourth quarter, while weak sectors like energy fared worse. Many companies oriented to U.S. consumers, from retailers to home builders to transportation companies, performed extremely well.
Some analysts see plenty of reasons for the good profits to keep coming, and in a broader range of companies. J.P. Morgan's Mr. Cliggott, for example, points to his current favorite filter for analyzing the market's heaps of data: looking at earnings for the S&P 500 with each component company given equal weighting, rather than weighting according to market capitalization.
This view removes the distortion created when immensely popular and profitable companies like Microsoft overshadow less profitable companies with far smaller market capitalizations. Operating income for S&P 500 companies measured on a standard, market-capitalization-weighted basis started improving in the second half of last year, Mr. Cliggott says. But on an "equal-weighted basis," he continues, operating income fell 5.3% in the third quarter and 2.5% in the fourth quarter -- but finally rebounded 4.8% last quarter.
Behind those numbers are scores of companies doing better than they were a year ago. With the domestic economic environment showing nary a sign of slowing, companies tied to the U.S. economy are faring well.
Makers of consumer cyclicals -- goods that sell better in a stronger economy -- had a great quarter in terms of operating income. With consumers on a tear, cars and trucks flew out of North American showrooms. Consumer cyclicals as a group posted a 15% gain in operating income, although net income fell 45%, mainly because of Ford's one-time gain last year. Net income for the auto makers fell 79%.
Despite trouble at Compaq Computer, which dumped its chief executive as the company struggled to deal with inventory problems, most computer makers did well as sales of PCs and powerful computer servers continued to accelerate. Computer manufacturers reported that net income rose 55% from the previous year, while office-equipment makers saw net income jump 102%, although both of those numbers reflect very easy comparisons with last year, when many technology companies were mired in excess inventory.
Some analysts anticipate a slowdown in computer sales when companies ease back on purchases of new systems as they complete preparations for the year-2000 computer problem. But others point out that the real strength in computers has been in home machines anyway, sales of which haven't accelerated because of Y2K and so shouldn't slow down either. "Tech is alive and well," Morgan Stanley Dean Witter's Mr. Rauscher says.
More PC sales in the first quarter brought more sales of software to run on the new machines. Software makers reported net income was up 34%.
Retailers, which will report first-quarter profits later this month, are expected to post better results thanks to the shopping-crazed U.S. consumer.
The companies that provide the shipping and trucking services to deliver all the goods Americans bought, both in stores and over the Internet, performed well. With fuel prices still low early in the quarter, trucking companies notched a 39% increase in net income, while air-freight companies scored an 89% increase in earnings. (Higher fuel prices now, however, many start to damp earnings growth for the second quarter.)
Still, weakness in other industrial areas such as heavy machinery weighed down the sector: Net income for 116 industrial firms tracked by the Journal fell 7%.
While international economies may not have recovered yet, international financial markets certainly have come far. That has been a boon to banks and securities firms, which suffered mightily from losses in trading and lending as markets from Asia to Russia to Latin America tanked last year. In the first quarter, money-center banks posted a 41% gain in net income, and securities firms saw a 39% increase, thanks largely to the benign securities-trading environment. Domestically oriented banks also performed well, although their year-to-year comparison is less impressive because they weren't hit so badly last year.
Energy companies have been among the worst hit by the global slump in demand. The first quarter provided little relief from that trend. Net income for the energy sector as a whole fell 50%, with every subsector, from integrated oil companies to pipeline providers, getting pummeled.
First Call's Mr. Hill, however, points to a possible hint of hope, not just for oil companies but for many other commodities producers as well. In preceding quarters, he notes, securities analysts have cut their earnings forecasts even after companies reported better-than-expected earnings. But now, as operating income has exceeded analysts' mean forecasts by 4.9%, many analysts have responded by finally raising their forecasts.
Risks remain. On one hand, the global recovery so many are anticipating could fail to materialize. Japan has barely begun climbing out of a decade-long slump, while Southeast Asian nations have yet to undergo the painful debt workouts and corporate restructurings that will put them on the road to sustainable growth. While Latin American economies may have stabilized, they aren't going to be strong markets for U.S.-made goods this year. And Europe has been worrying many observers with signs of weakness in its key economies.
The clear sign of increased global demand will be rising commodities prices, argues Kenneth T. Mayland, chief economist at KeyCorp. And while oil prices are up considerably this year, prices for raw materials such as steel and copper scrap, cotton and rubber have simply stabilized at a six-year low. Little wonder that net income in the basic-materials sector -- which includes companies such as Bethlehem Steel, forest-products group Louisiana-Pacific and Dow Chemical -- fell 34%.
Others argue that stability alone in commodities prices will make a big difference. "To me, it is always the incremental change that matters," J.P. Morgan's Mr. Cliggott says. While commodities prices aren't rising yet, a "change in the rate of change" will allow these companies to start increasing profits again.
On the other hand, global growth presents risks as well. Cheap commodities have helped keep the U.S. economy from overheating as it revved faster than most economists once thought was safe. If prices for raw materials start to rise as manufacturers move to meet the growing demand of newly healthy economies, the Federal Reserve may finally feel obliged to stomp out emerging signs of inflation.
Merrill's Mr. Bernstein, for example, argues vehemently that cyclical companies like commodities producers can make profits only if they can charge higher prices for their goods. Higher prices mean higher inflation. "I'm still basically a disinflationist, so I don't think earnings are going to be that good, because there's going to be disinflation," he says. "But the more wrong I am, the more likely it is that the Fed is going to hike rates."
Among industry groups, managed-care companies, which have struggled for several years to improve lackluster earnings, continue to face serious challenges in rising medical costs due to drug prices and expensive new technology. They also have been troubled by losses in their Medicare business.
The industry was shaken when Humana announced that its first-quarter profit would be well below forecasts due to rising medical costs. But some of those concerns were allayed when giant Aetna posted a 7.1% increase in net income and its operating earnings easily surpassed Wall Street estimates. The company's Aetna U.S. Healthcare unit controlled medical costs by driving tough bargains with doctors and hospitals and passing more of the costs of pricey prescription drugs onto consumers. Like other HMOs, Aetna also exited from unprofitable Medicare markets at the beginning of this year and raised employer premiums for the first quarter.
On the hospital side, many big players are still suffering from a revamped Medicare-reimbursement system and slow payments from managed-care companies. Hospitals also experienced low admissions at the beginning of the year, because of a mild winter, and then benefited from a surge in admissions in March with the late outbreak of flu.
Earnings at the nation's computer makers mostly roared ahead, despite serious setbacks at Compaq and some warnings that the year-2000 problem could harm sales later in the year. International Business Machines raced past analysts' expectation with a 42% gain in earnings, powered by a surprising 17% increase in hardware sales. Dell Computer continued to outpace competitors with direct sales of PCs to businesses and consumers. Sun Microsystems is still benefiting from the explosive growth of the Internet, posting a 13% gain in profit as its revenues from sales of powerful server computers surged.
Auto makers expect hot North American sales of their hugely profitable light trucks and sport-utility vehicles to fuel a second quarter as lucrative as the first. General Motors, Ford and DaimlerChrysler all benefited from the strength of the U.S. market and sales of trucks and SUVs, which can fetch profits of more than $10,000 a vehicle. All three said they expect the good times to roll on in the coming quarter.
Still, the road ahead won't be all smooth -- although the world's biggest auto market, North America, remains torrid, price competition is intensifying in Europe, and Latin America and Asia are expected to remain weak. Analysts also caution that the comparisons get tougher in the months ahead. Most first-quarter results looked strong partly because of double-digit monthly sales jumps in the U.S. But in the second quarter, the industry will be up against very robust year-earlier sales.
Oil-company earnings were blistered by the lowest crude-oil prices in more than a decade, compounded by an unusually warm winter. Integrated oil companies were hurt across the board, with income before unusual items falling as much as 80%. Oil-services and drilling companies were also pounded, as most energy firms slammed the brakes on exploration and drilling spending. Some saw large contracts canceled; Ensco, for instance, recognized $20.4 million of revenue in the quarter from a contract termination.
Still, a jump in prices in March, after the Organization of Petroleum Exporting Countries promised production cuts, boosted results at the end of the quarter and helped many energy concerns beat analysts' estimates. Texaco's and Ashland's earnings included gains from revaluing inventory to market values; before special items, Ashland's income fell 77%, to about $6 million. The higher prices are giving the industry hope that the year will turn out better than it started. Improvements in Asian refining units and higher oil prices have several executives predicting that the second quarter will produce higher earnings after a year of sliding profits.
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