From: owner-canslim-digest@lists.xmission.com (canslim-digest) To: canslim-digest@lists.xmission.com Subject: canslim-digest V2 #2548 Reply-To: canslim Sender: owner-canslim-digest@lists.xmission.com Errors-To: owner-canslim-digest@lists.xmission.com Precedence: bulk Content-Transfer-Encoding: quoted-printable X-No-Archive: yes canslim-digest Sunday, June 30 2002 Volume 02 : Number 2548 In this issue: Re: [CANSLIM] Now Xerox? ---------------------------------------------------------------------- Date: Fri, 28 Jun 2002 22:09:19 -0400 From: "Tom Worley" Subject: Re: [CANSLIM] Now Xerox? This is a multi-part message in MIME format. - ------=_NextPart_000_017A_01C21EF0.731C6420 Content-Type: text/plain; charset="iso-8859-1" Content-Transfer-Encoding: quoted-printable Ernie, I agree in part, history does tend to repeat itself, so claims of = somehow "this time it is different" has to be taken with a large grain = of salt. On the other hand, times are indeed changing, just as they have = for several hundred years. During my years as an active stock broker, I = had clients in about 20 states, so got a lot of feedback on a very human = level from all parts of the country. My assessment of sentiment, and = "M", was influenced by that very subjective feedback. I regularly talked = with all my clients, and often not about their holdings as much as their = investment goals, risk tolerance, etc. I taught them to focus more on = the overall performance of their portfolio than on individual stock = performance. I also observed a steady erosion of the percentage of = clients willing to invest in individual stocks while seeing a greater = willingness to buy funds. Many people simply don't have the time to do = the work that individual stocks take, preferring instead to leave = management, and research, and decision making, up to the = "professionals".=20 Even today I still have a lot of people asking me for advice on which = funds they should buy, or whether they should hold the ones they already = own. My answer is simple, and consistent, they need to determine their = own investment goals, and risk tolerance, then select a class of funds = that meet that criteria. I also remind them to always review fund = performance over a 3 to 5 year period, nothing shorter. I know many = people with substantial money in funds that have not looked at a chart = of the DOW, or the S&P500, in over a year. They just keep adding to = their funds regularly and don't worry about what the market is doing day = to day, or weekly, or even monthly. I also think investors that wish to be are better informed these days. = Part of that is the internet, part is simply being more sophisticated in = understanding investing. All of this contributes, in my opinion, to a = higher percentage of "active" investors paying far less attention to the = market's overall performance, and thus less affected by "fear". - ----- Original Message -----=20 From: Hill, Ernie=20 To: 'canslim@lists.xmission.com'=20 Sent: Friday, June 28, 2002 6:47 PM Subject: RE: [CANSLIM] Now Xerox? Sam =20 You, IMHO are of course right. =20 The mantra of "this time it is different" to me is a little humorous. 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 idea 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". =20 My reference to arrogance was not directed at any individual in this = group, rather I was speaking of the mass psychology of the investment = community that propelled our recently busted bubble. =20 E=20 =20 - -----Original Message----- From: Sam Funchess [mailto:sam5@mindspring.com] Sent: Friday, June 28, 2002 4:26 PM To: canslim@lists.xmission.com Subject: Re: [CANSLIM] Now Xerox? =20 Winston,=20 The way I read your statement is that, This time is different. We can = not look to history to provide an accurate 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 speculation bubble any different then = than any other time? I think the past 2 years has told us that this = bubble was no different. It is always nice to think 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 time 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 that 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 those 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 scared 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 point 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. 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. Please let the group know your = answer.=20 Your comment to the "The larger population of individuals will also = contain a larger number of people who know no fear." This seems = irrational 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?=20 This being said, I think that anybody 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. Are you? Are you = selling?=20 What is the general market tell you? I read and have read for the past = 2 years to be in cash. That is where I have been and am enjoying using = my cash for other non-stock market investments. I have kept two = investments in small portfolios only because 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.=20 Sam=20 Winston Little wrote:=20 "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.Thus I wonder if = the exhibition of fear will be as large or severe as in the past. =20 - ----- Original Message ----- From: Sam Funchess To: canslim@lists.xmission.com Sent: Friday, June 28, 2002 3:36 PM Subject: Re: [CANSLIM] Now Xerox? Canslim Members,=20 Been a while since my last post.=20 With that being said, I think the "scandal's" are very good for the long = 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 lot about the fear factor. We have not had the "Fear" in the market = yet. I think that there is no sustainable upside to the market until = the fear has hit the market.=20 Just my thoughts.=20 Sam=20 Katherine Malm wrote:=20 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=20 =20 The Earnings Confidence Problem - Part I =20 25-Jun-02 14:18 ET =20 =20 =20 [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. =20 The Market Problems The current market suffers from the following ailments: =20 a.. Distrust of management - from excessive comp to outright = fraud. Tyco is the best example. =20 b.. Distrust of accounting - Andersen =20 c.. Distrust of analysts - Blodgett =20 These three problems get all the press and attention. =20 But a deeper problem is afflicting the buy side - a growing = concern about the validity of earnings reporting. =20 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. =20 But in the last five years, the types of earnings that companies = have driven Wall Street to focus upon have become questionable. =20 There are four different basic types of earnings today: =20 a.. 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. =20 b.. As reported: Earnings excluding extraordinary items (as = defined by GAAP), changes in accounting charges, charges related to = discontinued operations (plant closings, etc.) =20 c.. Operating earnings: As reported earnings but excluding = "one-time" charges which do not fit the GAAP definition of = "extraordinary" =20 d.. Proforma earnings: Loosely defined "as if" analysis. = Originally designed to provide comparison data for mergers. =20 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. =20 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. =20 GAAP covers expenses as well as revenues, of course. =20 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." =20 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. =20 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. =20 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. =20 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. =20 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. =20 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. =20 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. =20 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. =20 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. =20 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.) =20 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!. =20 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.=20 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.) =20 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. =20 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. =20 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. =20 Amazon.com still reports earnings on a pro-forma basis. In their = Q1 income statement, you can take your choice of earnings: =20 a.. Pro-forma: $25 million profit =20 b.. Operating: $2 million profit =20 c.. Net (as-reported): $(23) million loss =20 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.=20 After all, value to you is primarily determined by what someone = else will pay, not by what you pay. =20 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. =20 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%. =20 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. =20 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. =20 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. =20 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. =20 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. =20 Comments may be emailed to the author, Robert V. Green, at = rvgreen@briefing.com =20 - ----- Original Message ----- From: Winston 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=20 crook ... they all have a smell about them.=20 - ----- Original Message -----=20 From: "Kelly Short" =20 To: =20 Sent: Friday, June 28, 2002 9:46 AM=20 Subject: [CANSLIM] Now Xerox?=20 =20 Enron, WorldCom- nothing. Xerox off by $6B. (Yes- that's "B" as in boy!) = Kelly=20 =20 - - -To subscribe/unsubscribe, email "majordomo@xmission.com" -In the = email body, write "subscribe canslim" or -"unsubscribe canslim". Do not = use quotes in your email. ****************************************************************** This email and any files transmitted with it from the ElPaso=20 Corporation are confidential and intended solely for the=20 use of the individual or entity to whom they are addressed.=20 If you have received this email in error please notify the=20 sender. ****************************************************************** - - -To subscribe/unsubscribe, email "majordomo@xmission.com" -In the = email body, write "subscribe canslim" or -"unsubscribe canslim". Do not = use quotes in your email. - ------=_NextPart_000_017A_01C21EF0.731C6420 Content-Type: text/html; charset="iso-8859-1" Content-Transfer-Encoding: quoted-printable
Ernie, I agree in part, history does tend to = repeat=20 itself, so claims of somehow "this time it is different" has to be taken = with a=20 large grain of salt. On the other hand, times are indeed changing, just = as they=20 have for several hundred years. During my years as an active stock = broker, I had=20 clients in about 20 states, so got a lot of feedback on a very human = level from=20 all parts of the country. My assessment of sentiment, and "M", was = influenced by=20 that very subjective feedback. I regularly talked with all my clients, = and often=20 not about their holdings as much as their investment goals, risk = tolerance, etc.=20 I taught them to focus more on the overall performance of their = portfolio than=20 on individual stock performance. I also observed a steady erosion of the = percentage of clients willing to invest in individual stocks while = seeing a=20 greater willingness to buy funds. Many people simply don't have the time = to do=20 the work that individual stocks take, preferring instead to leave = management,=20 and research, and decision making, up to the "professionals". =
 
Even today I still have a lot of people asking = me for=20 advice on which funds they should buy, or whether they should hold the = ones they=20 already own. My answer is simple, and consistent, they need to determine = their=20 own investment goals, and risk tolerance, then select a class of funds = that meet=20 that criteria. I also remind them to always review fund performance over = a 3 to=20 5 year period, nothing shorter. I know many people with substantial = money in=20 funds that have not looked at a chart of the DOW, or the S&P500, in = over a=20 year. They just keep adding to their funds regularly and don't worry = about what=20 the market is doing day to day, or weekly, or even monthly.
 
I also think investors that wish to be are = better informed=20 these days. Part of that is the internet, part is simply being more=20 sophisticated in understanding investing. All of this contributes, in my = opinion, to a higher percentage of "active" investors paying far less = attention=20 to the market's overall performance, and thus less affected by=20 "fear".
 
----- Original Message -----=20
From: Hill, Ernie=20
Sent: Friday, June 28, 2002 6:47 PM
Subject: RE: [CANSLIM] Now Xerox?

Sam

 

You,=20 IMHO are of course right.

 

The=20 mantra of =93this time it is different=94 to me is a little humorous. I = can=92t help=20 but smile as I write this (guess I am a little sadistic). History = repeats itself=20 because of human nature, and part of human nature is the arrogant idea = that we=20 some how have it all figure out better than those who preceded us. The=20 psychology of freely traded markets will never change, and while I have = no=20 historical reference I am sure that in past investment bubbles there = were plenty=20 of people who believed =93this time it is=20 different=94.

 

My=20 reference to arrogance was not directed at any individual in this group, = rather=20 I was speaking of the mass psychology of the investment community that = propelled=20 our recently busted bubble.

 

E=20

 

-----Original=20 Message-----
From: = Sam Funchess=20 [mailto:sam5@mindspring.com]
Sent: Friday, June 28, 2002 4:26=20 PM
To:=20 canslim@lists.xmission.com
Subject: Re: [CANSLIM] Now=20 Xerox?

 

Winston,=20

The way I read = your statement=20 is that, This time is different.  We can not look to history to = provide an=20 accurate view of our current economic times.  I ask, were you = thinking the=20 same thoughts in 1999 as the market was going ever higher?  Was the = speculation bubble any different then than any other time?  I think = the=20 past 2 years has told us that this bubble was no different.  It is = always=20 nice to think that this time is different but haw many times has it = been? =20 Sure our society has been trained to believe in the long term fund and = that over=20 time it will average out.  I ask you, the fund managers are just as = scared=20 if not more so in today's current economic time.  Who pay's the = fund=20 managers their large salary.  It is you and whoever invests in = their=20 fund.  If you have poor performance over several years, you have a = large=20 likelihood that your customers will leave.  So you are fearful that = you=20 will not come close to the averages and lose your customers and = therefore your=20 job.  The thirty something's like myself are in for the long = haul. =20 How about those investors that are in their 50's (what percentage of the = population is 50 or older?  A Large Percentage!)  They have = watched=20 their portfolio shrink dramatically over the past couple of years and = they will=20 become scared enough to remove their cash from funds.  When will = that=20 be?  When fear has hit the market.  Everybody, young and old, = are=20 still waiting for the market to continue its "normal upward movement" = and at=20 some point people will begin to question if the market is a good place = to keep=20 their investment or is it better to plow all their money into a larger=20 house.  Unless of course, the market begins its upward trend.  = Ask=20 anybody you know that is older than 50 who has large mutual fund = holdings if=20 they have moved any of their money or if they intend to in the near=20 future.  Please let the group know your answer.

Your = comment to the=20 "The larger population of = individuals will=20 also contain a larger number of people who know no fear." This seems = irrational=20 at first sight as averages stay relatively the same.  As the = population=20 grows, wouldn't it be reasonable to expect that the same percentage of = risk=20 takers will be born?  Why would the larger population mean that = there is a=20 larger population of risk takers?

This being said, = I think that=20 anybody who believes "this time is different" is fooling themselves and = being=20 wishful.  If you are a value investor for the long haul, you should = be=20 buying everything that you have researched and like at a maddening = pace. =20 Are you?  Are you selling?

What is the = general market=20 tell you?  I read and have read for the past 2 years to be in = cash. =20 That is where I have been and am enjoying using my cash for other = non-stock=20 market investments.  I have kept two investments in small = portfolios only=20 because I have been too lazy to remove them.  i kick myself for = being so=20 lazy as I have lost a decent amount of money.  Oh well.  The = market=20 told me to get out and stay out for the time being.

Sam
Winston = Little wrote:=20

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

----- = Original Message=20 - -----

From: Sam=20 Funchess

To: canslim@lists.xmission.com=

Sent: Friday, = June 28, 2002=20 3:36 PM

Subject: Re: = [CANSLIM] Now=20 Xerox?

 Canslim Members, =

Been a while since my last post. =

With that being said, I think = the=20 "scandal's" are very good for the long term benefit of CANSLIMers and = the=20 market.  Its been a while since I've read HTMMIS so I can't quote = chapters=20 or such, but I recall him talking a lot about the fear factor.  We = have not=20 had the "Fear" in the market yet.  I think that there is no = sustainable=20 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=20 Briefing.com for those less familiar with EBITDA, etc. --Katherine PS = Xerox's=20 accounting woes go back *years*.... = P-U....=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D

The Earnings Confidence = Problem -=20 Part I

25-Jun-02=20 14:18 ET

 

[BRIEFING.COM - Robert V. = Green] In=20 the midst of the more scandalous market problems, the earnings = confidence=20 problem is not receiving the attention it should. Here is more on = the=20 topic. 

The Market=20 Problems

The current market suffers = from the=20 following ailments: 

  • Distrust of management - = from=20 excessive comp to outright fraud. Tyco is the best=20 example. =20
  • Distrust of accounting - = Andersen =20
  • Distrust of analysts -=20 Blodgett =20

These three problems get = all the=20 press and attention. 

But a deeper problem is = afflicting=20 the buy side - a growing concern about the validity of earnings=20 reporting. 

The Earnings=20 Problem

Accounting rules have = always been=20 flexible enough to allow most companies a far amount of = flexibility both=20 in revenue recognition and expense recognition. Even when earnings = reporting was somewhat standardized, some companies were = criticized for=20 how they recognized revenue and expense. 

But in the last five = years, the=20 types of earnings = that=20 companies have driven Wall Street to focus upon have become=20 questionable. 

There are four different = basic types=20 of earnings today: 

  • GAAP earnings: Generally = Accepted=20 Accounting Principles - A standards board that publishes rules = on how=20 expenses should be booked. Generally, all types of expenses are=20 deducted. =20
  • As reported: Earnings = excluding=20 extraordinary items (as defined by GAAP), changes in accounting = charges,=20 charges related to discontinued operations (plant closings,=20 etc.) =20
  • Operating earnings: As = reported=20 earnings but excluding "one-time" charges which do not fit the = GAAP=20 definition of "extraordinary" =20
  • Proforma earnings: = Loosely defined=20 "as if" analysis. Originally designed to provide comparison data = for=20 mergers. =20

GAAP accounting principles = are=20 guidelines for accountants, not investors. The GAAP standards are=20 guidelines for how a company should keep its books, not how the = company=20 should report earnings. 

For example, a basic = principle=20 behind GAAP is that revenue must be booked over the time period = for which=20 services and product are delivered. If a two year $200,000 = contract is=20 pre-paid in cash, up front, the entire $200,000 cannot be booked = in the=20 quarter in which the contract is signed. However, the revenue does = not=20 have to be booked as $25,000 per quarter for two years. A fair = amount of=20 flexibility, sometimes negotiated by auditors, is possible for how = much of=20 a contract can be booked in each quarter.  =

GAAP covers expenses as = well as=20 revenues, of course. 

As=20 reported=20 earnings are the historical standard for earnings. Until the = mid-eighties,=20 in fact, there was little debate over how earnings should be = reported as=20 everyone used "as reported" earnings as a standard. For the most = part,=20 there was no difference between "as reported" earnings and any = other=20 methodology because one-time charges were not as common. = Furthermore,=20 companies did not actively seek, as they do today, to have certain = expenses classified as "one-time." 

Operating=20 earnings=20 are designed to allow comparisons between quarters and years for a = company. One time charges in any quarter are excluded because = these would=20 distort the comparison. Operating earnings became important when = it became=20 clear that Wall Street would completely ignore any "one-time" = charges, and=20 focus solely on earnings growth. This provided a strong incentive = for=20 companies to classify large expenses as one-time charges. =20

An example of one = company's=20 aggressive attempt to get charges classified as one-time was = Excite's 1997=20 $40 million marketing deal with Netscape. Now long forgotten, = Excite paid=20 Netscape up-front for a four-year deal to be the principal search = engine=20 at the Netscape web site. Excite tried to classify the entire $40 = million=20 payment as a one-time charge in a single quarter. By doing so, = Excite was=20 almost profitable. At Briefing we highlighted this event as an = indicator=20 of the times. The SEC later forced Excite to restate the payment = as a=20 four-year expense. But many, many companies were successful in = getting=20 major expense outlays classified as "one-time" which improved = income=20 statements. 

The focus on operating = expenses led=20 to the development of the "EBITDA" concept, which is "Earnings = Before=20 Interest, Taxes, Depreciation, and Amortization." The EBITDA = concept,=20 which has to be calculated from the line items shown on an = operating=20 earnings report, was designed to show the basic business model of = the=20 company, without regard to cost-of-capital. If capital were free, = then=20 EBITDA would be earnings. 

The focus on EBITDA has = fallen from=20 favor in recent times for one single reason: Interest. The interest = payments on=20 bonds, which are excluded from EBITDA calculations, has ruined = many=20 debt-ridden. 

Only through focusing on = EBITDA=20 projections could a company like Exodus Communications raise so = much debt=20 that their interest payments exceeded their gross margin. That = won't=20 happen again for decades. 

Pro-forma=20 earnings=20 are very hard to define today. The original purpose of pro-forma = earnings=20 calculations was to show the effects of a merger in a format that = allowed=20 a single income statement to combine only the operating models of = each=20 company, and exclude the actual costs of making the merger. =20

Under the pro-forma for = merger=20 guidelines, pro-forma calculations could only be used for one = year, after=20 which the company should start reporting as-reported earnings for = the=20 combined entities. 

However, companies soon = learned that=20 as long as they made a new merger each year, they could continue = reporting=20 pro-forma earnings indefinitely. This "flexibility" in how = earnings could=20 be reported led to "pro-forma" meanings that were never intended,=20 including stock option compensation expenses and R&D = "in-progress"=20 write-offs. 

The Erosion of Earnings=20 Confidence

The now long-departed CFO = of=20 Amazon.com, Joy Covey, was the unsung hero of bringing pro-forma = earnings=20 to the popularity they enjoyed. She did so by diverting attention = away=20 from standardized earnings reports. 

Ms. Covey invented the = concept of=20 "EBITMA" which was defined "EBITDA plus marketing." She was = successful in=20 convincing Wall Street that marketing=20 costs were equivalent to capital investment, a concept = which=20 looks ridiculous in retrospect. But in the early days of the = internet,=20 marketing and brand development was equated with capturing = "territory"=20 which, presumably, everyone thought could never be lost. (Tell = that to=20 investors in Excite.) 

Nevertheless, Joy Covey = was=20 successful in convincing investors, particularly convertible bond=20 investors, to focus on the EBITMA concept. It was a crucial = element in=20 selling the $2 billion in Amazon.com bonds that built the company. = After=20 all, if you ignore the interest payments on the bond, and you = consider=20 spending the bond principal on marketing as "not an expense," = Amazon's=20 income statement would look great!. 

The problem, of course, is = that bond=20 holders don't care about earnings statements. They just care about = the=20 payments. The jury is still out on whether Amazon.com will = eventually be=20 able to pay the principal on their bonds. (See the Stock Brief of: = 14-May-01=20 Amazon.com's Bond Problem.

After Joy Covey = established the=20 principle of EBITMA, internet companies began using all types of=20 non-earnings related statistics to show growth. Page views, = registered=20 users, unique monthly visitors are just some of the meaningless = examples=20 that became popular. (Surely you remember.)  =

When "non-revenue = statistics"=20 becoming drivers of stock prices, (around 1998) pro-forma earnings = increased in popularity. After all, a pro-forma income statement = that=20 showed some kind of=20 earnings progress looked a lot more "real" than the = phony=20 statistics being coughed up by internet companies. =20

But when the bubble = collapsed,=20 everyone began = questioning=20 earnings quality. It didn't happen overnight, and it didn't happen = all at=20 once. But as a long, slow evolutionary force, earnings confidence = has=20 eroded, and is still present today. 

The = Aftermath

The evolution of earnings = focus over=20 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=20 a pro-forma basis. In their Q1 income statement, you can take your = choice=20 of earnings: 

  • Pro-forma: $25 million=20 profit =20
  • Operating: $2 million=20 profit =20
  • Net (as-reported): $(23) = million=20 loss =20

The earnings format = you choose is not = relevant, frankly.=20 It is far more important to the stock value what format the guy next to you = chooses.=20

After all, value to you is primarily = determined by=20 what someone else will pay, not by what you pay.  =

Even = GE

Even solid companies like = General=20 Electric have come under scrutiny because of the extremely complex = financial situations. Unraveling a GE earnings report has now = become a=20 major task. Where GE only had to beat earnings estimates by $0.01 = each=20 quarter to count on an ever increasing stock price, today that is = not=20 enough. 

GE = stock is down=20 50% in the last two years despite having only missed one earnings = estimate=20 in the last four years and having continual year-over-year growth = in=20 earnings averaging 15%. 

This bears repeating: GE, = as=20 representative a stock as you can get of the overall economy, is = down 50%=20 since September 2000. During that time period, they have grown = earnings at=20 over 11% (year-to-year basis) and beat or met earnings estimates = every=20 quarter except one. The one shortfall was October 2001, the = quarter of the=20 Attack on America and GE was only one penny short. =20

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

Flat or declining revenue = combined=20 with continuing increasing earnings leads to only one conclusion: = you can't keep this up forever.=20 Eventually, GE will be unable to book the earnings = number=20 higher than previous years. When (if), that happens, GE stock will = be=20 further devastated. Until then, the slow erosion of confidence = causes the=20 stock price to decline. 

GE is just one good = example of how=20 confidence in earnings numbers has been eroding over time since = the bubble=20 collapse. Until greater confidence in earnings numbers is = established, you=20 can expect further difficulties in the market overall. =20

Standard & Poors is = now pushing=20 for a standardized calculation for earnings reporting, called Core = Earnings. We will have more on this concept in Part II of this = story, to=20 appear later this week. 

Comments may be emailed to = the=20 author, Robert V. Green, at rvgreen@briefing.com

----- = Original Message=20 - -----

From: Winston=20 Little

To: canslim@lists.xmission.com=

Sent: Friday, = June 28, 2002=20 9:47 AM

Subject: Re: = [CANSLIM] Now=20 Xerox?

 They all used EBITDA.. = which Warren=20 Buffett in May said is the currency of a
crook ... they all have a = smell=20 about them.

----- Original Message ----- =
From:=20 "Kelly Short" <kelly.short@neoris.com> =
To:=20 <canslim@lists.xmission.com= >=20
Sent: Friday, June 28, 2002 9:46 AM
Subject: [CANSLIM] Now = Xerox?=20
 

Enron, WorldCom- nothing. Xerox = off by=20 $6B. (Yes- that's "B" as in boy!)

Kelly =
 

- -To subscribe/unsubscribe, = email=20 "majordomo@xmission.com" -In the email body, write "subscribe canslim" = or=20 - -"unsubscribe canslim". Do not use quotes in your = email.



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