"The reason every developed economy uses standardized accounting rules is to give investors a modicum of insight into what is going on in a company, compare these numbers to those of other companies, and make at least not totally ignorant investment decisions.
In the US, these are the generally accepted accounting principles, or GAAP, the most despised acronym of Wall Street and Corporate America. Yet even these principles offer plenty of flexibility for financial statement beautification. We get that.
Yet they’re way too harsh for Wall Street. So companies file the required financial statements under GAAP for everyone to look at, but then they hype their “adjusted” earnings in their communications with investors. And the gap between the two in 2015 was a doozie
While companies can play with revenues to some extent, it’s more complicated and not nearly as rewarding as “adjusting” their profits. That’s the easiest thing to do in the world. A few keystrokes will do. There are no rules or laws against it, so long as it’s called something like “adjusted earnings.” The rewards are huge, in terms of share prices, stock options, bonuses, and for Wall Street, fees. The ultimate target of the magic is earnings per share. EPS is the most crucial term in the canon of the markets.
Turns out, the 2015 “growth” in earnings, and particularly the “growth” in EPS – so a decline – as reported by FactSet and others is a figment of the vivid imagination of Wall Street and Corporate America, called “adjusted earnings,” where everything bad has been “adjusted” out of it.
For example, of the 30 components of the Dow Jones Industrial Average, 20 reported “adjusted” earnings, with 18 of them reporting adjusted earnings that were higher than their earnings under GAAP, according to FactSet. That 18-to-2 relationship alone shows the clear bias of these adjustments: They’re used to inflate earnings, not to lower them to some more realistic level.
These adjusted EPS were on average 31% higher in 2015 than EPS under GAAP. That’s way up from 2014 when 19 of the Dow components reported adjusted earnings that were on average 12% higher than under GAAP.
And yet, despite the soaring portion of fiction, these adjusted EPS of the companies in the DOW still declined 4.8%. That’s bad enough. But under GAAP, beautified as it might have been, EPS plunged 12.3%.
The biggest sinners?
Merck & Co. won hands-down: it reported adjusted fictional EPS of $3.59 for 2015; but under GAAP, its earnings dwindled to $1.56 per share. Its elegant adjustments inflated EPS by 130%! You’d think it would take some balls to somehow get this by keen-eyed Wall Street analysts. But no. Wall Street ate it up. Consensual hallucination.
GE reported EPS of a measly $0.17 for the entire year 2015 under GAAP, but once it got through with excising all the bad stuff, EPS jumped 106% to $0.35. OK, that’s still crummy….
Our tech-darling Microsoft reported EPS of $1.48 under GAAP, and so its financial-statement beauticians set out to do their magic and adjusted them up by 78% to $2.63. Pfizer inflated its EPS under GAAP of $1.24 by 77% to $2.20. And United Technologies, in this elegant manner, raised its EPS by 40% to an adjusted $6.30.
These are among the most established members of Corporate America. Other companies, which were not part of FactSet’s report, were much more extreme.
18 comments:
It might be safer to purchase CDs, but my bank is only paying 1.05% for a one year CD, and 1.75% for a 6 year CD.
Years ago, I used to buy CDs and get between 6% and 8%.
The line "Goodwill" under assets should always be mentally translated as "Air."
If you want to be safe, Treasury TIPS bonds in a 401k (so you don't have to pay current taxes on inflation) but of course you do when you cash out.
Or, up to I think $10k a year, in Treasury Direct I-bonds, which likewise are inflation protected and have no current taxes but mature on you in 30 years when you will owe taxes.
Otherwise long term bonds are risky because they plummet in value if interest rates rise, Treasury or not.
The advice is based on your not being likelty to beat inflation anyway with stocks on the average.
Interest rates will always more or less match inflation.
Stocks are more fun, though.
Burton Malkiel "A Random Walk Down Wall Street" is the bible and has been since the 70s or whenever it was written, so you don't get taken in by financial advisors.
With low inflation, interest rates are low too, so you're living off principal if you're retired (the interest doesn't cover expenses, say).
But that's actually true even with high interest and high inflation. You live fine on the high interest, but unnoticed the principal is declining in value owing to inflation.
So either way comes out the same. Just spend a constant percentage on expenses and your principal will last forever either way, with the same real effect.
Interesting that EOG lowered theirs by 70%. Everyone knows what the E stands for, right?
What does the initials EOG stand for? I tried to find out, but couldn't.
Enron Oil & Gas
Thanks, Leland. I was unaware that they are still in business. Guess that's why I didn't find out what EOG stood for. I even went to their website.
The problem with the advice to go super-safe is that the market should have collapsed at least a decade ago...but it hasn't. And in all the years of non-collapse the people who went super-safe have earned practically ZERO on their principal. The market doesn't collapse, it has corrections, sometimes 10% sometimes as much as 20% but 1929 all over again?...a long shot.
That doesn't mean I would recommend investing in so-called junk at this point. I wouldn't. But I'm in junk and have been for 20 years, earning about 6% on my principal investment all that time. Could I end up living under a bridge? Yes. But that would mean the worldwide financial system would first have to blow up. I'm betting it won't.
I used to invest in CD's but now I just download I Tunes.
The stock market is a weird place where being right on the underlying facts means almost nothing, despite that they spend endless hours talking about it. All that matters is correctly predicting the almost entirely uninformed or mal-informed herd and their passions. It's just like politics. Nobody really cares about any facts other than who are the winners, and winners get accredited with instant wisdom and ability. You can be consistently right about everything else, but unless you pick the herd's winners, you won't be listened to. You could have a dozen smart financial experts in the room, but the guy who won the lottery will have more people at his table, and they won't benefit one cent from it.
The line "Goodwill" under assets should always be mentally translated as "Air."
Mostly true. In businesses, in some cases the Goodwill can be something of actual value. As a former lender it was pretty much a judgement call if I was going to consider "goodwill" as an actual asset or discount it from the owner's inflated view of the value.
In the case of the US Government, full faith and credit it is absolutely air and a fairy tale. The Feds do not have the funds to pay out on the existing bonds. Generally what happens when a block of bonds come due, like the ones that China and other foreign countries are holding, the Feds will hold an auction for NEW bonds to replace the old. The auction is the rate that the government will pay out on the new bonds. If the rate is too low, no one buys and the rate keeps getting adjusted until the new money comes in to pay off the old bonds.
In a good case scenario, the Chinese will not demand their money back when the bonds come due and let them roll over. However, given the abysmal rate of return on current bonds and the bankrupt status of the United States the Chinese are likely to take their money and run. Invest somewhere that there is a better rate of return and with a country that can actually PAY if the bonds are redeemed.
The US Government debt is backed by worthless paper, borrowing funds with borrowed money. Anyone who puts their money into a low return, artificially depressed interest rate investment that has a negative return (you are losing money due to inflation), a long term investment that you cannot sell at a break even point, that is guaranteed to lose value when/if rates ever rise.....is a fool.
You would get better appreciation on your funds by buying junk in garage sales and selling on Ebay than investing in US Treasuries.
Stocks EPS and other factors are definitely subject to manipulation by various accounting tricks. The annual reports and associated supporting documents are incomprehensible to pretty much everyone. Nevertheless, for most investors in vehicles like IRAs and 401Ks the only growth potential IS in stocks.
I took all money out of the stock market in 2010 to fund the turn around of my company, and then I just put extra cash in the bank until last month when I put a small amount in an index fund. I made more money the first month on that small investment than I did from all my bank interest over 6 years. The current situation is great to borrow in, but cash is almost useless for growth. You don't want to pay down debt, because it's so cheap now, and everybody has been saying that rates have to rise, but they just don't. I just wish the government would tell me what to do.
Trooper, thou art most wise.
Thank you all! You are The Best.
My sense is that the Market is set up for periodic crashes. The the scaredy cats sell and people like Soros buy low. It's just the timing that matters, i.e., at what age should one cash out?
DBQ, where would the Chinese go? Aren't we in a sort of an intertwined death clinch with them?
I wonder if as the world shrinks and trade barriers become more and more permeable, that part of the solution (it already is) is for incoming Chinese to buy up land, etc., I read they have bought up a lot of Detroit, and I think, farmland.
As a general rule investment in solid, blue chip stocks pays out better yields than CD's except in the years and, occasionally, decades that they don't. If you're distrustful of the machinations of Wall St., just buy Berkshire shares and let Buffet do the research. He's had some years where he's underperformed the market, but those who stuck with him have had reason to celebrate their fidelity.
Zero coupon bonds (corporate for IRAS/401ks/HR10s) munis for non tax sheltered, historically are the way to go. One can often buy them at less than 50 cents on the dollar and at maturity one will have doubled one's money--a pretty safe way to go--although today's low interest rates make this strategy harder and harder to make work.
The US can't default on their debt. It's denominated in dollars, which they can print. Unlike states or cities.
AllenS, EOG is hardly the same Enron. It was a division of the former company that was spun off before Enron Corp. Still, it shows that while some board members were greedy, the people within the company are good people. Unfortunately, some seem to forgot those things in the desire to dehumanize things they don't like.
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