The Earnings Confidence Problem - Part I
25-Jun-02 14:18 ET

[BRIEFING.COM - Robert V. Green] In the midst of the more scandalous market problems, the earnings confidence problem is not receiving the attention it should. Here is more on the topic. The Market Problems The current market suffers from the following ailments: Distrust of management - from excessive comp to outright fraud. Tyco is the best example. Distrust of accounting - Andersen Distrust of analysts - Blodgett These three problems get all the press and attention. But a deeper problem is afflicting the buy side - a growing concern about the validity of earnings reporting. The Earnings Problem Accounting rules have always been flexible enough to allow most companies a far amount of flexibility both in revenue recognition and expense recognition. Even when earnings reporting was somewhat standardized, some companies were criticized for how they recognized revenue and expense. But in the last five years, the types of earnings that companies have driven Wall Street to focus upon have become questionable. There are four different basic types of earnings today: GAAP earnings: Generally Accepted Accounting Principles - A standards board that publishes rules on how expenses should be booked. Generally, all types of expenses are deducted. As reported: Earnings excluding extraordinary items (as defined by GAAP), changes in accounting charges, charges related to discontinued operations (plant closings, etc.) Operating earnings: As reported earnings but excluding "one-time" charges which do not fit the GAAP definition of "extraordinary" Proforma earnings: Loosely defined "as if" analysis. Originally designed to provide comparison data for mergers. GAAP accounting principles are guidelines for accountants, not investors. The GAAP standards are guidelines for how a company should keep its books, not how the company should report earnings. For example, a basic principle behind GAAP is that revenue must be booked over the time period for which services and product are delivered. If a two year $200,000 contract is pre-paid in cash, up front, the entire $200,000 cannot be booked in the quarter in which the contract is signed. However, the revenue does not have to be booked as $25,000 per quarter for two years. A fair amount of flexibility, sometimes negotiated by auditors, is possible for how much of a contract can be booked in each quarter. GAAP covers expenses as well as revenues, of course. As reported earnings are the historical standard for earnings. Until the mid-eighties, in fact, there was little debate over how earnings should be reported as everyone used "as reported" earnings as a standard. For the most part, there was no difference between "as reported" earnings and any other methodology because one-time charges were not as common. Furthermore, companies did not actively seek, as they do today, to have certain expenses classified as "one-time." Operating earnings are designed to allow comparisons between quarters and years for a company. One time charges in any quarter are excluded because these would distort the comparison. Operating earnings became important when it became clear that Wall Street would completely ignore any "one-time" charges, and focus solely on earnings growth. This provided a strong incentive for companies to classify large expenses as one-time charges. An example of one company's aggressive attempt to get charges classified as one-time was Excite's 1997 $40 million marketing deal with Netscape. Now long forgotten, Excite paid Netscape up-front for a four-year deal to be the principal search engine at the Netscape web site. Excite tried to classify the entire $40 million payment as a one-time charge in a single quarter. By doing so, Excite was almost profitable. At Briefing we highlighted this event as an indicator of the times. The SEC later forced Excite to restate the payment as a four-year expense. But many, many companies were successful in getting major expense outlays classified as "one-time" which improved income statements. The focus on operating expenses led to the development of the "EBITDA" concept, which is "Earnings Before Interest, Taxes, Depreciation, and Amortization." The EBITDA concept, which has to be calculated from the line items shown on an operating earnings report, was designed to show the basic business model of the company, without regard to cost-of-capital. If capital were free, then EBITDA would be earnings. The focus on EBITDA has fallen from favor in recent times for one single reason: Interest. The interest payments on bonds, which are excluded from EBITDA calculations, has ruined many debt-ridden. Only through focusing on EBITDA projections could a company like Exodus Communications raise so much debt that their interest payments exceeded their gross margin. That won't happen again for decades. Pro-forma earnings are very hard to define today. The original purpose of pro-forma earnings calculations was to show the effects of a merger in a format that allowed a single income statement to combine only the operating models of each company, and exclude the actual costs of making the merger. Under the pro-forma for merger guidelines, pro-forma calculations could only be used for one year, after which the company should start reporting as-reported earnings for the combined entities. However, companies soon learned that as long as they made a new merger each year, they could continue reporting pro-forma earnings indefinitely. This "flexibility" in how earnings could be reported led to "pro-forma" meanings that were never intended, including stock option compensation expenses and R&D "in-progress" write-offs. The Erosion of Earnings Confidence The now long-departed CFO of Amazon.com, Joy Covey, was the unsung hero of bringing pro-forma earnings to the popularity they enjoyed. She did so by diverting attention away from standardized earnings reports. Ms. Covey invented the concept of "EBITMA" which was defined "EBITDA plus marketing." She was successful in convincing Wall Street that marketing costs were equivalent to capital investment, a concept which looks ridiculous in retrospect. But in the early days of the internet, marketing and brand development was equated with capturing "territory" which, presumably, everyone thought could never be lost. (Tell that to investors in Excite.) Nevertheless, Joy Covey was successful in convincing investors, particularly convertible bond investors, to focus on the EBITMA concept. It was a crucial element in selling the $2 billion in Amazon.com bonds that built the company. After all, if you ignore the interest payments on the bond, and you consider spending the bond principal on marketing as "not an expense," Amazon's income statement would look great!. The problem, of course, is that bond holders don't care about earnings statements. They just care about the payments. The jury is still out on whether Amazon.com will eventually be able to pay the principal on their bonds. (See the Stock Brief of: 14-May-01 Amazon.com's Bond Problem. After Joy Covey established the principle of EBITMA, internet companies began using all types of non-earnings related statistics to show growth. Page views, registered users, unique monthly visitors are just some of the meaningless examples that became popular. (Surely you remember.) When "non-revenue statistics" becoming drivers of stock prices, (around 1998) pro-forma earnings increased in popularity. After all, a pro-forma income statement that showed some kind of earnings progress looked a lot more "real" than the phony statistics being coughed up by internet companies. But when the bubble collapsed, everyone began questioning earnings quality. It didn't happen overnight, and it didn't happen all at once. But as a long, slow evolutionary force, earnings confidence has eroded, and is still present today. The Aftermath The evolution of earnings focus over the past 10 years has led us to today's situation: a basic lack of confidence in many companies income statements. Amazon.com still reports earnings on a pro-forma basis. In their Q1 income statement, you can take your choice of earnings: Pro-forma: $25 million profit Operating: $2 million profit Net (as-reported): $(23) million loss The earnings format you choose is not relevant, frankly. It is far more important to the stock value what format the guy next to you chooses. After all, value to you is primarily determined by what someone else will pay, not by what you pay. Even GE Even solid companies like General Electric have come under scrutiny because of the extremely complex financial situations. Unraveling a GE earnings report has now become a major task. Where GE only had to beat earnings estimates by $0.01 each quarter to count on an ever increasing stock price, today that is not enough. GE stock is down 50% in the last two years despite having only missed one earnings estimate in the last four years and having continual year-over-year growth in earnings averaging 15%. This bears repeating: GE, as representative a stock as you can get of the overall economy, is down 50% since September 2000. During that time period, they have grown earnings at over 11% (year-to-year basis) and beat or met earnings estimates every quarter except one. The one shortfall was October 2001, the quarter of the Attack on America and GE was only one penny short. Why can't GE get any respect? The only definable long-term culprit is a decline in confidence in GE's earnings numbers. During the same eight quarter time-period, GE revenue growth rate has been consistently falling. From a growth rate of 24% and 20% in 00Q1 and 00Q2, growth has steadily fallen, and even was negative for most of 2001. Flat or declining revenue combined with continuing increasing earnings leads to only one conclusion: you can't keep this up forever. Eventually, GE will be unable to book the earnings number higher than previous years. When (if), that happens, GE stock will be further devastated. Until then, the slow erosion of confidence causes the stock price to decline. GE is just one good example of how confidence in earnings numbers has been eroding over time since the bubble collapse. Until greater confidence in earnings numbers is established, you can expect further difficulties in the market overall. Standard & Poors is now pushing for a standardized calculation for earnings reporting, called Core Earnings. We will have more on this concept in Part II of this story, to appear later this week. Comments may be emailed to the author, Robert V. Green, at rvgreen@briefing.com

25-Jun-02 14:18 ET

[BRIEFING.COM - Robert V. Green] In the midst of the more scandalous market problems, the earnings confidence problem is not receiving the attention it should. Here is more on the topic.

The Market Problems

The current market suffers from the following ailments:

Distrust of management - from excessive comp to outright fraud. Tyco is the best example.
Distrust of accounting - Andersen
Distrust of analysts - Blodgett

These three problems get all the press and attention.

But a deeper problem is afflicting the buy side - a growing concern about the validity of earnings reporting.

The Earnings Problem

Accounting rules have always been flexible enough to allow most companies a far amount of flexibility both in revenue recognition and expense recognition. Even when earnings reporting was somewhat standardized, some companies were criticized for how they recognized revenue and expense.

But in the last five years, the types of earnings that companies have driven Wall Street to focus upon have become questionable.

There are four different basic types of earnings today:

GAAP earnings: Generally Accepted Accounting Principles - A standards board that publishes rules on how expenses should be booked. Generally, all types of expenses are deducted.
As reported: Earnings excluding extraordinary items (as defined by GAAP), changes in accounting charges, charges related to discontinued operations (plant closings, etc.)
Operating earnings: As reported earnings but excluding "one-time" charges which do not fit the GAAP definition of "extraordinary"
Proforma earnings: Loosely defined "as if" analysis. Originally designed to provide comparison data for mergers.

GAAP accounting principles are guidelines for accountants, not investors. The GAAP standards are guidelines for how a company should keep its books, not how the company should report earnings.

For example, a basic principle behind GAAP is that revenue must be booked over the time period for which services and product are delivered. If a two year $200,000 contract is pre-paid in cash, up front, the entire $200,000 cannot be booked in the quarter in which the contract is signed. However, the revenue does not have to be booked as $25,000 per quarter for two years. A fair amount of flexibility, sometimes negotiated by auditors, is possible for how much of a contract can be booked in each quarter.

GAAP covers expenses as well as revenues, of course.

As reported earnings are the historical standard for earnings. Until the mid-eighties, in fact, there was little debate over how earnings should be reported as everyone used "as reported" earnings as a standard. For the most part, there was no difference between "as reported" earnings and any other methodology because one-time charges were not as common. Furthermore, companies did not actively seek, as they do today, to have certain expenses classified as "one-time."

Operating earnings are designed to allow comparisons between quarters and years for a company. One time charges in any quarter are excluded because these would distort the comparison. Operating earnings became important when it became clear that Wall Street would completely ignore any "one-time" charges, and focus solely on earnings growth. This provided a strong incentive for companies to classify large expenses as one-time charges.

An example of one company's aggressive attempt to get charges classified as one-time was Excite's 1997 $40 million marketing deal with Netscape. Now long forgotten, Excite paid Netscape up-front for a four-year deal to be the principal search engine at the Netscape web site. Excite tried to classify the entire $40 million payment as a one-time charge in a single quarter. By doing so, Excite was almost profitable. At Briefing we highlighted this event as an indicator of the times. The SEC later forced Excite to restate the payment as a four-year expense. But many, many companies were successful in getting major expense outlays classified as "one-time" which improved income statements.

The focus on operating expenses led to the development of the "EBITDA" concept, which is "Earnings Before Interest, Taxes, Depreciation, and Amortization." The EBITDA concept, which has to be calculated from the line items shown on an operating earnings report, was designed to show the basic business model of the company, without regard to cost-of-capital. If capital were free, then EBITDA would be earnings.

The focus on EBITDA has fallen from favor in recent times for one single reason: Interest. The interest payments on bonds, which are excluded from EBITDA calculations, has ruined many debt-ridden.

Only through focusing on EBITDA projections could a company like Exodus Communications raise so much debt that their interest payments exceeded their gross margin. That won't happen again for decades.

Pro-forma earnings are very hard to define today. The original purpose of pro-forma earnings calculations was to show the effects of a merger in a format that allowed a single income statement to combine only the operating models of each company, and exclude the actual costs of making the merger.

Under the pro-forma for merger guidelines, pro-forma calculations could only be used for one year, after which the company should start reporting as-reported earnings for the combined entities.

However, companies soon learned that as long as they made a new merger each year, they could continue reporting pro-forma earnings indefinitely. This "flexibility" in how earnings could be reported led to "pro-forma" meanings that were never intended, including stock option compensation expenses and R&D "in-progress" write-offs.

The Erosion of Earnings Confidence

The now long-departed CFO of Amazon.com, Joy Covey, was the unsung hero of bringing pro-forma earnings to the popularity they enjoyed. She did so by diverting attention away from standardized earnings reports.

Ms. Covey invented the concept of "EBITMA" which was defined "EBITDA plus marketing." She was successful in convincing Wall Street that marketing costs were equivalent to capital investment, a concept which looks ridiculous in retrospect. But in the early days of the internet, marketing and brand development was equated with capturing "territory" which, presumably, everyone thought could never be lost. (Tell that to investors in Excite.)

Nevertheless, Joy Covey was successful in convincing investors, particularly convertible bond investors, to focus on the EBITMA concept. It was a crucial element in selling the $2 billion in Amazon.com bonds that built the company. After all, if you ignore the interest payments on the bond, and you consider spending the bond principal on marketing as "not an expense," Amazon's income statement would look great!.

The problem, of course, is that bond holders don't care about earnings statements. They just care about the payments. The jury is still out on whether Amazon.com will eventually be able to pay the principal on their bonds. (See the Stock Brief of: 14-May-01 Amazon.com's Bond Problem.

After Joy Covey established the principle of EBITMA, internet companies began using all types of non-earnings related statistics to show growth. Page views, registered users, unique monthly visitors are just some of the meaningless examples that became popular. (Surely you remember.)

When "non-revenue statistics" becoming drivers of stock prices, (around 1998) pro-forma earnings increased in popularity. After all, a pro-forma income statement that showed some kind of earnings progress looked a lot more "real" than the phony statistics being coughed up by internet companies.

But when the bubble collapsed, everyone began questioning earnings quality. It didn't happen overnight, and it didn't happen all at once. But as a long, slow evolutionary force, earnings confidence has eroded, and is still present today.

The Aftermath

The evolution of earnings focus over the past 10 years has led us to today's situation: a basic lack of confidence in many companies income statements.

Amazon.com still reports earnings on a pro-forma basis. In their Q1 income statement, you can take your choice of earnings:

Pro-forma: $25 million profit
Operating: $2 million profit
Net (as-reported): $(23) million loss

The earnings format you choose is not relevant, frankly. It is far more important to the stock value what format the guy next to you chooses.

After all, value to you is primarily determined by what someone else will pay, not by what you pay.

Even GE

Even solid companies like General Electric have come under scrutiny because of the extremely complex financial situations. Unraveling a GE earnings report has now become a major task. Where GE only had to beat earnings estimates by $0.01 each quarter to count on an ever increasing stock price, today that is not enough.

GE stock is down 50% in the last two years despite having only missed one earnings estimate in the last four years and having continual year-over-year growth in earnings averaging 15%.

This bears repeating: GE, as representative a stock as you can get of the overall economy, is down 50% since September 2000. During that time period, they have grown earnings at over 11% (year-to-year basis) and beat or met earnings estimates every quarter except one. The one shortfall was October 2001, the quarter of the Attack on America and GE was only one penny short.

Why can't GE get any respect? The only definable long-term culprit is a decline in confidence in GE's earnings numbers. During the same eight quarter time-period, GE revenue growth rate has been consistently falling. From a growth rate of 24% and 20% in 00Q1 and 00Q2, growth has steadily fallen, and even was negative for most of 2001.

Flat or declining revenue combined with continuing increasing earnings leads to only one conclusion: you can't keep this up forever. Eventually, GE will be unable to book the earnings number higher than previous years. When (if), that happens, GE stock will be further devastated. Until then, the slow erosion of confidence causes the stock price to decline.

GE is just one good example of how confidence in earnings numbers has been eroding over time since the bubble collapse. Until greater confidence in earnings numbers is established, you can expect further difficulties in the market overall.

Standard & Poors is now pushing for a standardized calculation for earnings reporting, called Core Earnings. We will have more on this concept in Part II of this story, to appear later this week.

Comments may be emailed to the author, Robert V. Green, at rvgreen@briefing.com

Sam

<= /span>

You, IMHO are of course right.

<= /span>

The mantra of “this time it is different” to me is a little humorou= s. I can’t help but smile as I write this (guess I am a little sadistic). History repeats itself because of human nature, and part of human nature is the arrogant id= ea that we some how have it all figure out better than those who preceded us. = The psychology of freely traded markets will never change, and while I have no historical reference I am sure that in past investment bubbles there were plenty of people who believed “this time it is different”.=

<= /span>

My reference to arrogance was not directed at any individual in this group, ra= ther I was speaking of the mass psychology of the investment community that prop= elled our recently busted bubble.

<= /span>

-----Original Message-----
From: Sam Funchess [mailto:sam5@mindspring.com]
Sent: Friday, June 28, 2002 = 4:26 PM
To: canslim@lists.xmission.c= om
Subject: Re: [CANSLIM] Now X= erox?

<= /o:p>

Winst= on,

The way I read your statement is tha= t, This time is different. We can not look to history to provide an accu= rate view of our current economic times. I ask, were you thinking the same thoughts in 1999 as the market was going ever higher? Was the specula= tion bubble any different then than any other time? I think the past 2 yea= rs has told us that this bubble was no different. It is always nice to t= hink that this time is different but haw many times has it been? Sure our society has been trained to believe in the long term fund and that over tim= e it will average out. I ask you, the fund managers are just as scared if = not more so in today's current economic time. Who pay's the fund managers their large salary. It is you and whoever invests in their fund. = ; If you have poor performance over several years, you have a large likelihood t= hat your customers will leave. So you are fearful that you will not come close to the averages and lose your customers and therefore your job. = The thirty something's like myself are in for the long haul. How about th= ose investors that are in their 50's (what percentage of the population is 50 or older? A Large Percentage!) They have watched their portfolio shrink dramatically over the past couple of years and they will become scar= ed enough to remove their cash from funds. When will that be? When fear has hit the market. Everybody, young and old, are still waiting = for the market to continue its "normal upward movement" and at some p= oint people will begin to question if the market is a good place to keep their investment or is it better to plow all their money into a larger house.&nbs= p; Unless of course, the market begins its upward trend. Ask anybody you know that is older than 50 who has large mutual fund holdings if they have moved any of their money or if they intend to in the near future. Ple= ase let the group know your answer.

Your comment to the "The larger population of individuals= will also contain a larger number of people who know no fear." This seems i= rrational at first sight as averages stay relatively the same. As the population grows, wouldn't it be reasonable to expect that the same percentage of risk takers will be born? Why would the larger population mean that there = is a larger population of risk takers?

This being said, I think that anybod= y who believes "this time is different" is fooling themselves and being wishful. If you are a value investor for the long haul, you should be buying everything that you have researched and like at a maddening pace.&nb= sp; Are you? Are you selling?

What is the general market tell you?= I read and have read for the past 2 years to be in cash. That is wher= e I have been and am enjoying using my cash for other non-stock market investments. I have kept two investments in small portfolios only bec= ause I have been too lazy to remove them. i kick myself for being so lazy = as I have lost a decent amount of money. Oh well. The market told me= to get out and stay out for the time being. =

Sam
Winston Little wrote:

"The market= always climbs a wall of worry" is an old familiar saying. In 1965 only 10%= of the population invested in the market.(Just over 50% of trading volume was by individuals)The participation grew to 60% of the population in April 2002 (either directly or through retirement/mutual funds). The volume due to individuals fell to under 20%. Fund managers may not have the same = fear as an individual (it is not HIS/HER money, but YOURS!)The larger population= of individuals will also contain a larger number of people who know no fear.Th= us I wonder if the exhibition of fear will be as large or severe as in the past.=

----- Original Message -----

From: Sam Funch= ess

To: canslim@lists.xmission.com

Sent: Friday, June 28, = 2002 3:36 PM

Subject: Re: [CANSLIM] Now Xerox?

= ;Canslim Members,

Been a while since my last post.

With that being said, I think the "scandal's" are very good for the lo= ng term benefit of CANSLIMers and the market. Its been a while since I've read HTMMIS so I can't quote chapters or such, but I recall him talking a l= ot about the fear factor. We have not had the "Fear" in the ma= rket yet. I think that there is no sustainable upside to the market until = the fear has hit the market.

Just my thoughts.

Sam

Katherine Malm wrote:

Here's some background on earnings from Briefing.com for those less familiar with EBITDA, etc. --Katherine PS Xerox's accounting woes go back *years*.... P-U....=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D

The Market Problems<= font color=3Dblack><= /o:p>

Distrust of management - from excessive comp to outrigh= t fraud. Tyco is the best example.

Distrust of accounting - Andersen <= o:p>

Distrust of analysts - Blodgett <= o:p>

But a deeper problem is afflicting the buy side - a growing concern about the validity of earnings reporting. <= /o:p>

The Earnings Problem= <= /o:p>

But in the last five years, the types of earnings that companies h= ave driven Wall Street to focus upon have become questionable. <= /font><= /o:p>

There are four different basic types of earnings today:

GAAP earnings: Generally Accepted Accounting Principles= - A standards board that publishes rules on how expenses should be booke= d. Generally, all types of expenses are deducted. <= o:p>

As reported: Earnings excluding extraordinary items (as defined by GAAP), changes in accounting charges, charges related to discontinued operations (plant closings, etc.) <= o:p>
Operating earnings: As reported earnings but excluding "one-time" charges which do not fit the GAAP definition of "extraordinary"

Proforma earnings: Loosely defined "as if" analysis. Originally designed to provide comparison data for mergers.

GAAP accounting principles are guid= elines for accountants, not investors. The GAAP standards are guidelines for how= a company should keep its books, not how the company should report earnings.

For example, a basic principle behind GAAP is that revenue must be booked over the time period for which services and product are delivered. If a two year $200,000 contract is pre-paid in cash, up fr= ont, the entire $200,000 cannot be booked in the quarter in which the contract= is signed. However, the revenue does not have to be booked as $25,000 per quarter for two years. A fair amount of flexibility, sometimes negotiated= by auditors, is possible for how much of a contract can be booked in each quarter.

GAAP covers expenses as well as revenues, of course.

As reported earnings are the historical st= andard for earnings. Until the mid-eighties, in fact, there was little debate ov= er how earnings should be reported as everyone used "as reported" earnings as a standard. For the most part, there was no difference between "as reported" earnings and any other methodology because one-ti= me charges were not as common. Furthermore, companies did not actively seek,= as they do today, to have certain expenses classified as "one-time." <= /p>

Operating earnings= are designed to allow comparis= ons between quarters and years for a company. One time charges in any quarter= are excluded because these would distort the comparison. Operating earnings became important when it became clear that Wall Street would completely ignore any "one-time" charges, and focus solely on earnings gro= wth. This provided a strong incentive for companies to classify large expenses= as one-time charges. <= /p>

An example of one company's aggressive attempt to get charges classified as one-time was Excite's 1997 $40 million marketing de= al with Netscape. Now long forgotten, Excite paid Netscape up-front for a four-year deal to be the principal search engine at the Netscape web site. Excite tried to classify the entire $40 million payment as a one-time cha= rge in a single quarter. By doing so, Excite was almost profitable. At Briefi= ng we highlighted this event as an indicator of the times. The SEC later for= ced Excite to restate the payment as a four-year expense. But many, many companies were successful in getting major expense outlays classified as "one-time" which improved income statements. <= /o:p>

The focus on operating expenses led to the developmen= t of the "EBITDA" concept, which is "Earnings Before Interest, Taxes, Depreciation, and Amortization." The EBITDA concept, which ha= s to be calculated from the line items shown on an operating earnings report, = was designed to show the basic business model of the company, without regard = to cost-of-capital. If capital were free, then EBITDA would be earnings.&nbs= p; <= /o:p>

The focus on EBITDA has fallen from favor in recent t= imes for one single reason: Interest. The interest payments on bonds, which are excluded from EBITDA calculatio= ns, has ruined many debt-ridden. <= /p>

Pro-forma earnings= are very hard to define today.= The original purpose of pro-forma earnings calculations was to show the effec= ts of a merger in a format that allowed a single income statement to combine only the operating models of each company, and exclude the actual costs o= f making the merger.

Under the pro-forma for merger guidelines, pro-forma calculations could only be used for one year, after which the company sho= uld start reporting as-reported earnings for the combined entities. <= /o:p>

However, companies soon learned that as long as they = made a new merger each year, they could continue reporting pro-forma earnings indefinitely. This "flexibility" in how earnings could be repor= ted led to "pro-forma" meanings that were never intended, including stock option compensation expenses and R&D "in-progress" write-offs.

The Erosion of Earnings Confidence= <= /o:p>

Ms. Covey invented the concept of "EBITMA" which was defined "EBITDA plus marketing." She was successful in convincing Wall Street that marketing costs were equivalent to capital investment, a concept which l= ooks ridiculous in retrospect. But in the early days of the internet, marketing and brand development was equated with capturing "territory" wh= ich, presumably, everyone thought could never be lost. (Tell that to investors= in Excite.)

Nevertheless, Joy Covey was successful in convincing investors, particularly convertible bond investors, to focus on the EBITMA concept. It was a crucial element in selling the $2 billion in Amazon.com bonds that built the company. After all, if you ignore the interest payme= nts on the bond, and you consider spending the bond principal on marketing as "not an expense," Amazon's income statement would look great!.

The problem, of course, is that bond holders don't ca= re about earnings statements. They just care about the payments. The jury is still out on whether Amazon.com will eventually be able to pay the princi= pal on their bonds. (See the Stock Brief of: 14-May-01 Amazon.com's Bond Problem. <= /p>

After Joy Covey established the principle of EBITMA, internet companies began using all types of non-earnings related statisti= cs to show growth. Page views, registered users, unique monthly visitors are just some of the meaningless examples that became popular. (Surely you remember.)

When "non-revenue statistics" becoming driv= ers of stock prices, (around 1998) pro-forma earnings increased in popularity. After all, a pro-forma income statement that showed some kind of earnings progress loo= ked a lot more "real" than the phony statistics being coughed up by internet companies. <= /p>

The Aftermath<= /o:p>

Amazon.com still reports earnings on a pro-forma basi= s. In their Q1 income statement, you can take your choice of earnings: = <= /o:p>

Pro-forma: $25 million profit <= o:p>
Operating: $2 million profit <= o:p>
Net (as-reported): $(23) million loss <= o:p>

After all, value to you is primarily determined by what someone else will pay, not= by what you pay.

Even GE<= /b>

GE stock is down 50% in the last two years despite having only missed one earnings estimate in the last four y= ears and having continual year-over-year growth in earnings averaging 15%.&nbs= p; <= /p>
This bears repeating: GE, as representative a stock as you can get of the overall economy, is down 50% since September 2000. Dur= ing that time period, they have grown earnings at over 11% (year-to-year basi= s) and beat or met earnings estimates every quarter except one. The one shortfall was October 2001, the quarter of the Attack on America and GE w= as only one penny short. <= /p>
Why can't GE get any respect? The only definable long-term culprit is a decline in confidence in GE's earnings numbers. Du= ring the same eight quarter time-period, GE revenue growth rate has been consistently falling. From a growth rate of 24% and 20% in 00Q1 and 00Q2, growth has steadily fallen, and even was negative for most of 2001. = <= /o:p>

Flat or declining revenue combined with continuing increasing earnings leads to only one conclusion: you can't keep this up forever. Eventually, GE will be unable to book the earnings number higher than previous years. When (if), that happens, GE stock will be further devastated. Until then, the slow erosion of confidence causes the stock price to decline. <= /o:p>

GE is just one good example of how confidence in earn= ings numbers has been eroding over time since the bubble collapse. Until great= er confidence in earnings numbers is established, you can expect further difficulties in the market overall. <= /p>
Standard & Poors is now pushing for a standardized calculation for earnings reporting, called Core Earnings. We will have mo= re on this concept in Part II of this story, to appear later this week. = ; <= /o:p>

Comments may be emailed to the author, Robert V. Gree= n, at rvgreen@briefing.com<= /o:p>

----- Original Message -----

From: Winst= on Little

To: canslim@lists.xmission.com

Sent: Friday, June 28, 2002 9:47 AM

Subject: Re: [CANSLIM] Now Xerox?

They all used EBITDA.. which Warren Buffett in May said is the currency of a
crook ... they all have a smell about them.

----- Original Message -----
From: "Kelly Short" <kelly.short@neoris.com>
To: <canslim@lists.xmissio= n.com>
Sent: Friday, June 28, 2002 9:46 AM
Subject: [CANSLIM] Now Xerox?

Enron, WorldCom- nothing. Xerox off by $6B. (Yes- that's "B" as in boy!)=

Kelly

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