NEW YORK (AP) Lower earnings might not be such a bad thing for investors if they are coming down for the right reason.
Stricter accounting rules that recently went into effect now make it harder for companies to repeatedly exclude all sorts of special'' costs from their earnings and inflate corporate performance.
So come this earnings season as well as those in the months ahead, investors might see lower results but at least the numbers will better reflect how companies are really doing.
These changes, under new Securities and Exchange Commission regulations, are part of a push for greater corporate disclosure in the wake of all the business scandals over the last year and half.
Regulators aren't targeting the methodology used under Generally Accepted Accounting Principles, or GAAP. That's an all-inclusive, more conservative approach to crunching the bottom line, and the one the SEC requires in financial statements submitted to the regulatory agency.
Their focus is on pro forma, or adjusted, results. Those are the headline-grabbing figures that corporate America loves to promote in earnings news releases.
Companies prefer pro forma because they say it gives investors a better gauge of their operations by excluding special or one-time costs. Wall Street, too, has long favored these results over GAAP to value and analyze stocks.
Investors, however, complain that the increasing reliance on adjusted figures in recent years has become a way for companies to play down negative results. And, they say, companies do that by excluding costs for such things as restructurings and asset sales that really shouldn't be considered one-time expenses when they happen year after year.
So instead of giving a clearer view of a company's core business, as pro forma is intended, the adjusted numbers have become largely a misleading mess.
Some confirmation of that can be seen by the giant gap between actual earnings reported under GAAP and the pro forma results over the last decade.
For companies in the Standard & Poor's 500 stock index from 1991 to 2001, GAAP earnings were 16 percent lower than pro forma earnings. Last year, that widened to more than 40 percent, according to a recent report from the investment firm UBS Warburg's U.S. Valuation and Accounting Group.
In some cases, the GAAP and pro forma numbers don't even closely resemble one another.
Winn-Dixie Stores, for instance, reported cumulative pro forma earnings over the last three years of $397 million; under GAAP, it lost $500,000. Mattel's three-year cumulative pro form earnings were $826 million vs. a loss of $221 million under GAAP.
But the pro forma trickery will be much harder to do under the new SEC rules, which went into effect in late March as part of a drive to boost the quality and transparency of earnings.
Every company must now include the GAAP figures in their earnings releases, and if they also use pro forma, they have to explicitly detail how those numbers are calculated and how they differ from GAAP. In addition, companies cannot exclude charges that also have occurred in the past two years or could occur in the next two years.
Proctor & Gamble, for instance, has taken more than $3 billion in restructuring charges since 1999. Starting this summer, which is the end of its fiscal year, the consumer products company will count the costs as normal operating expenses.
Across corporate America, the implication of this change on earnings could be significant. The UBS Warburg report estimates it could knock as much as 10 percent off pro forma earnings over time.
In the coming quarters and perhaps in a year or two, we believe the new rules will unmask a lower level of normalized earnings than currently perceived by most investors,'' said David Bianco, author of the UBS Warburg report.
Pulling down the earnings facade is long overdue. Even if that means earnings take a hit, at least shareholders will have a truer gauge of their investments.
Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org
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