Go to Jeff Salisbury LWGate Home Page.From: "Winston Little" <wlittle1@peoplepc.com>
Subject: Re: [CANSLIM] Now Xerox?
Date: Fri, 28 Jun 2002 19:00:20 -0400
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History repeats itself and only the names and minute details are =
different.
History is a great teacher.
The points that I was trying to make are:
- - news travels faster with the use of internet and all business TV=20
- - fear rises and ebbs much quicker today, as releases and =
recommendations are touted on the net or on TV
- - fear is most extreme in individual investors not fund managers (how =
much fear has Blodget or Grubman shown?)
- - funds trade more than 80% of the volumes today which are about 2 =
billion shares/day ( lower levels of fear and not as sustained)
- - individuals traded more than 50% of the 15 million shares per day =
traded in 1965 era (so high sustained fear)
- - fund managers and analysts get paid so highly today that in one year =
they make more than the average Joe does in several lifetimes, and it =
takes several years before the managers get axed. So fear is not high =
priority for them.
----- Original Message -----=20
From: Sam Funchess=20
To: canslim@lists.xmission.com=20
Sent: Friday, June 28, 2002 5:26 PM
Subject: Re: [CANSLIM] Now Xerox?
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
=20
The Earnings Confidence Problem - Part I=20
25-Jun-02 14:18 ET=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" <kelly.short@neoris.com>=20
To: <canslim@lists.xmission.com>=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!)=20
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.
- -To subscribe/unsubscribe, email "majordomo@xmission.com" -In the =
email body, write "subscribe canslim" or -"unsubscribe canslim". Do not =
use quotes in your email.=20
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<META http-equiv=3DContent-Type content=3D"text/html; =
charset=3Diso-8859-1">
<META content=3D"MSHTML 5.50.4522.1800" name=3DGENERATOR></HEAD>
<BODY bgColor=3D#ffffff>
<DIV><FONT size=3D2>History repeats itself and only the names and minute =
details=20
are different.</FONT></DIV>
<DIV><FONT size=3D2>History is a great teacher.</FONT></DIV>
<DIV><FONT size=3D2></FONT> </DIV>
<DIV><FONT size=3D2>The points that I was trying to make =
are:</FONT></DIV>
<DIV><FONT size=3D2>- news travels faster with the use of internet and =
all=20
business TV </FONT></DIV>
<DIV><FONT size=3D2>- fear rises and ebbs much quicker today, as =
releases and=20
recommendations are touted on the net or on TV</FONT></DIV>
<DIV><FONT size=3D2>- fear is most extreme in individual investors not =
fund=20
managers (how much fear has Blodget or Grubman shown?)</FONT></DIV>
<DIV><FONT size=3D2>- funds trade more than 80% of the volumes today =
which are=20
about 2 billion shares/day ( lower levels of fear and not as=20
sustained)</FONT></DIV>
<DIV><FONT size=3D2>- individuals traded more than 50% of the 15 million =
shares=20
per day traded in 1965 era (so high sustained fear)</FONT></DIV>
<DIV><FONT size=3D2>- fund managers and analysts get paid so highly =
today that in=20
one year they make more than the average Joe does=20
in several lifetimes, and it takes several years before the =
managers=20
get axed. So fear is not high priority for them.</FONT></DIV>
<DIV><FONT size=3D2></FONT> </DIV>
<DIV><FONT size=3D2></FONT> </DIV>
<BLOCKQUOTE=20
style=3D"PADDING-RIGHT: 0px; PADDING-LEFT: 5px; MARGIN-LEFT: 5px; =
BORDER-LEFT: #000000 2px solid; MARGIN-RIGHT: 0px">
<DIV style=3D"FONT: 10pt arial">----- Original Message ----- </DIV>
<DIV=20
style=3D"BACKGROUND: #e4e4e4; FONT: 10pt arial; font-color: =
black"><B>From:</B>=20
<A title=3Dsam5@mindspring.com href=3D"mailto:sam5@mindspring.com">Sam =
Funchess</A> </DIV>
<DIV style=3D"FONT: 10pt arial"><B>To:</B> <A =
title=3Dcanslim@lists.xmission.com=20
=
href=3D"mailto:canslim@lists.xmission.com">canslim@lists.xmission.com</A>=
</DIV>
<DIV style=3D"FONT: 10pt arial"><B>Sent:</B> Friday, June 28, 2002 =
5:26 PM</DIV>
<DIV style=3D"FONT: 10pt arial"><B>Subject:</B> Re: [CANSLIM] Now =
Xerox?</DIV>
<DIV><BR></DIV>Winston,=20
<P>The way I read your statement is that, This time is =
different. We can=20
not look to history to provide an accurate view of our current =
economic=20
times. I ask, were you thinking the same thoughts in 1999 as the =
market=20
was going ever higher? Was the speculation bubble any different =
then=20
than any other time? I think the past 2 years has told us that =
this=20
bubble was no different. It is always nice to think that this =
time is=20
different but haw many times has it been? Sure our society has =
been=20
trained to believe in the long term fund and that over time it will =
average=20
out. I ask you, the fund managers are just as scared if not more =
so in=20
today's current economic time. Who pay's the fund managers their =
large=20
salary. It is you and whoever invests in their fund. If =
you have=20
poor performance over several years, you have a large likelihood that =
your=20
customers will leave. So you are fearful that you will not come =
close to=20
the averages and lose your customers and therefore your job. The =
thirty=20
something's like myself are in for the long haul. How about =
those=20
investors that are in their 50's (what percentage of the population is =
50 or=20
older? A Large Percentage!) They have watched their =
portfolio=20
shrink dramatically over the past couple of years and they will become =
scared=20
enough to remove their cash from funds. When will that be? =
When=20
fear has hit the market. Everybody, young and old, are still =
waiting for=20
the market to continue its "normal upward movement" and at some point =
people=20
will begin to question if the market is a good place to keep their =
investment=20
or is it better to plow all their money into a larger house. =
Unless of=20
course, the market begins its upward trend. Ask anybody you know =
that is=20
older than 50 who has large mutual fund holdings if they have moved =
any of=20
their money or if they intend to in the near future. Please let =
the=20
group know your answer. <BR><BR>Your comment to the "<FONT =
size=3D-1>The larger=20
population of individuals will also contain a larger number of people =
who know=20
no fear." This seems irrational at first sight as averages stay =
relatively the=20
same. As the population grows, wouldn't it be reasonable to =
expect that=20
the same percentage of risk takers will be born? Why would the =
larger=20
population mean that there is a larger population of risk =
takers?</FONT>=20
<P>This being said, I think that anybody who believes "this time is =
different"=20
is fooling themselves and being wishful. If you are a value =
investor for=20
the long haul, you should be buying everything that you have =
researched and=20
like at a maddening pace. Are you? Are you selling?=20
<P>What is the general market tell you? I read and have read for =
the=20
past 2 years to be in cash. That is where I have been and am =
enjoying=20
using my cash for other non-stock market investments. I have =
kept two=20
investments in small portfolios only because I have been too lazy to =
remove=20
them. i kick myself for being so lazy as I have lost a decent =
amount of=20
money. Oh well. The market told me to get out and stay out =
for the=20
time being.=20
<P>Sam <BR>Winston Little wrote:=20
<BLOCKQUOTE TYPE=3D"CITE"> <FONT size=3D-1>"The market always =
climbs a wall=20
of worry" is an old familiar saying.</FONT> <FONT size=3D-1>In =
1965 only=20
10% of the population invested in the market.(Just over 50% of =
trading=20
volume was by individuals)</FONT><FONT size=3D-1>The participation =
grew to 60%=20
of the population in April 2002 (either directly or through=20
retirement/mutual funds). The volume due to individuals fell to =
under=20
20%.</FONT> <FONT size=3D-1>Fund managers may not have the same =
fear as=20
an individual (it is not HIS/HER money, but YOURS!)</FONT><FONT =
size=3D-1>The=20
larger population of individuals will also contain a larger number =
of people=20
who know no fear.</FONT><FONT size=3D-1>Thus I wonder if the =
exhibition of=20
fear will be as large or severe as in the past.</FONT> =20
<BLOCKQUOTE=20
style=3D"PADDING-RIGHT: 0px; PADDING-LEFT: 5px; MARGIN-LEFT: 5px; =
BORDER-LEFT: #000000 2px solid; MARGIN-RIGHT: 0px">
<DIV style=3D"FONT: 10pt arial">----- Original Message -----</DIV>
<DIV=20
style=3D"BACKGROUND: #e4e4e4; FONT: 10pt arial; font-color: =
black"><B>From:</B>=20
<A title=3Dsam5@mindspring.com =
href=3D"mailto:sam5@mindspring.com">Sam=20
Funchess</A></DIV>
<DIV style=3D"FONT: 10pt arial"><B>To:</B> <A=20
title=3Dcanslim@lists.xmission.com=20
=
href=3D"mailto:canslim@lists.xmission.com">canslim@lists.xmission.com</A>=
</DIV>
<DIV style=3D"FONT: 10pt arial"><B>Sent:</B> Friday, June 28, 2002 =
3:36=20
PM</DIV>
<DIV style=3D"FONT: 10pt arial"><B>Subject:</B> Re: [CANSLIM] Now=20
Xerox?</DIV> Canslim Members,=20
<P>Been a while since my last post.=20
<P>With that being said, I think the "scandal's" are very good for =
the=20
long term benefit of CANSLIMers and the market. Its been a =
while=20
since I've read HTMMIS so I can't quote chapters or such, but I =
recall him=20
talking a lot about the fear factor. We have not had the =
"Fear" in=20
the market yet. I think that there is no sustainable upside =
to the=20
market until the fear has hit the market.=20
<P>Just my thoughts.=20
<P>Sam=20
<P>Katherine Malm wrote:=20
<BLOCKQUOTE TYPE=3D"CITE">
<STYLE></STYLE>
Here's some background on earnings from Briefing.com for those =
less=20
familiar with EBITDA, etc. --Katherine PS Xerox's accounting =
woes go=20
back *years*.... P-U....=3D=3D=3D=3D=3D=3D=3D=3D=3D=3D=20
<TABLE cellSpacing=3D0 cellPadding=3D4 width=3D"100%">
<CAPTION>
<TBODY><BR></TBODY><BR>
<TBODY><BR></TBODY></CAPTION>
<TBODY>
<TR>
<TD class=3Dheader>The Earnings Confidence Problem - Part =
I</TD></TR>
<TR>
<TD><B><FONT face=3DVerdana><FONT size=3D-2>25-Jun-02 14:18=20
ET</FONT></FONT></B></TD></TR>
<TR>
<TD height=3D8></TD></TR>
<TR>
<TD>[BRIEFING.COM - Robert V. Green] In the midst of the =
more=20
scandalous market problems, the earnings confidence =
problem is not=20
receiving the attention it should. Here is more on the=20
topic. =20
<H3>The Market Problems</H3>The current market suffers =
from the=20
following ailments: =20
<UL>
<LI>Distrust of management - from excessive comp to =
outright=20
fraud. Tyco is the best example. =20
<LI>Distrust of accounting - Andersen =20
<LI>Distrust of analysts - Blodgett =
</LI></UL>These three=20
problems get all the press and attention. =20
<P>But a deeper problem is afflicting the buy side - a =
growing=20
concern about the validity of earnings reporting. =20
<H3>The Earnings Problem</H3>Accounting rules have always =
been=20
flexible enough to allow most companies a far amount of=20
flexibility both in revenue recognition and expense =
recognition.=20
Even when earnings reporting was somewhat standardized, =
some=20
companies were criticized for how they recognized revenue =
and=20
expense. =20
<P>But in the last five years, the <I>types</I> of =
earnings that=20
companies have driven Wall Street to focus upon have =
become=20
questionable. =20
<P>There are four different basic types of earnings =
today: =20
<UL>
<LI>GAAP earnings: Generally Accepted Accounting =
Principles - A=20
standards board that publishes rules on how expenses =
should be=20
booked. Generally, all types of expenses are =
deducted. =20
<LI>As reported: Earnings excluding extraordinary items =
(as=20
defined by GAAP), changes in accounting charges, charges =
related=20
to discontinued operations (plant closings, etc.) =20
<LI>Operating earnings: As reported earnings but =
excluding=20
"one-time" charges which do not fit the GAAP definition =
of=20
"extraordinary" =20
<LI>Proforma earnings: Loosely defined "as if" analysis. =
Originally designed to provide comparison data for=20
mergers. </LI></UL><B>GAAP</B> 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=20
company should report earnings. =20
<P>For example, a basic principle behind GAAP is that =
revenue must=20
be booked over the time period for which services and =
product are=20
delivered. If a two year $200,000 contract is pre-paid in =
cash, up=20
front, the entire $200,000 cannot be booked in the quarter =
in=20
which the contract is signed. However, the revenue does =
not have=20
to be booked as $25,000 per quarter for two years. A fair =
amount=20
of flexibility, sometimes negotiated by auditors, is =
possible for=20
how much of a contract can be booked in each =
quarter. =20
<P>GAAP covers expenses as well as revenues, of =
course. =20
<P><B>As reported</B> earnings are the historical standard =
for=20
earnings. Until the mid-eighties, in fact, there was =
little debate=20
over how earnings should be reported as everyone used "as=20
reported" earnings as a standard. For the most part, there =
was no=20
difference between "as reported" earnings and any other=20
methodology because one-time charges were not as common.=20
Furthermore, companies did not actively seek, as they do =
today, to=20
have certain expenses classified as "one-time." =20
<P><B>Operating earnings</B> are designed to allow =
comparisons=20
between quarters and years for a company. One time charges =
in any=20
quarter are excluded because these would distort the =
comparison.=20
Operating earnings became important when it became clear =
that Wall=20
Street would completely ignore any "one-time" charges, and =
focus=20
solely on earnings growth. This provided a strong =
incentive for=20
companies to classify large expenses as one-time =
charges. =20
<P>An example of one company's aggressive attempt to get =
charges=20
classified as one-time was Excite's 1997 $40 million =
marketing=20
deal with Netscape. Now long forgotten, Excite paid =
Netscape=20
up-front for a four-year deal to be the principal search =
engine at=20
the Netscape web site. Excite tried to classify the entire =
$40=20
million payment as a one-time charge in a single quarter. =
By doing=20
so, Excite was almost profitable. At Briefing we =
highlighted this=20
event as an indicator of the times. The SEC later forced =
Excite to=20
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
<P>The focus on operating expenses led to the development =
of the=20
"EBITDA" concept, which is "Earnings Before Interest, =
Taxes,=20
Depreciation, and Amortization." The EBITDA concept, which =
has to=20
be calculated from the line items shown on an operating =
earnings=20
report, was designed to show the basic business model of =
the=20
company, without regard to cost-of-capital. If capital =
were free,=20
then EBITDA would be earnings. =20
<P>The focus on EBITDA has fallen from favor in recent =
times for=20
one single reason: <I>Interest.</I> The interest payments =
on=20
bonds, which are excluded from EBITDA calculations, has =
ruined=20
many debt-ridden. =20
<P>Only through focusing on EBITDA projections could a =
company=20
like Exodus Communications raise so much debt that their =
interest=20
payments exceeded their gross margin. That won't happen =
again for=20
decades. =20
<P><B>Pro-forma earnings</B> are very hard to define =
today. The=20
original purpose of pro-forma earnings calculations was to =
show=20
the effects of a merger in a format that allowed a single =
income=20
statement to combine only the operating models of each =
company,=20
and exclude the actual costs of making the merger. =20
<P>Under the pro-forma for merger guidelines, pro-forma=20
calculations could only be used for one year, after which =
the=20
company should start reporting as-reported earnings for =
the=20
combined entities. =20
<P>However, companies soon learned that as long as they =
made a new=20
merger each year, they could continue reporting pro-forma =
earnings=20
indefinitely. This "flexibility" in how earnings could be =
reported=20
led to "pro-forma" meanings that were never intended, =
including=20
stock option compensation expenses and R&D =
"in-progress"=20
write-offs. =20
<H3>The Erosion of Earnings Confidence</H3>The now =
long-departed=20
CFO of Amazon.com, Joy Covey, was the unsung hero of =
bringing=20
pro-forma earnings to the popularity they enjoyed. She did =
so by=20
diverting attention away from standardized earnings =
reports. =20
<P>Ms. Covey invented the concept of "EBITMA" which was =
defined=20
"EBITDA plus marketing." She was successful in convincing =
Wall=20
Street that <I>marketing costs were equivalent to capital=20
investment,</I> a concept which looks ridiculous in =
retrospect.=20
But in the early days of the internet, marketing and brand =
development was equated with capturing "territory" which,=20
presumably, everyone thought could never be lost. (Tell =
that to=20
investors in Excite.) =20
<P>Nevertheless, Joy Covey was successful in convincing =
investors,=20
particularly convertible bond investors, to focus on the =
EBITMA=20
concept. It was a crucial element in selling the $2 =
billion in=20
Amazon.com bonds that built the company. After all, if you =
ignore=20
the interest payments on the bond, and you consider =
spending the=20
bond principal on marketing as "not an expense," Amazon's =
income=20
statement would look great!. =20
<P>The problem, of course, is that bond holders don't care =
about=20
earnings statements. They just care about the payments. =
The jury=20
is still out on whether Amazon.com will eventually be able =
to pay=20
the principal on their bonds. (See the Stock Brief of: <A=20
=
href=3D"http://www.briefing.com/scripts/sub/stocks/PowerAnchor.asp?varArt=
icleID=3DSB20010514082806rvgreen">14-May-01=20
Amazon.com's Bond Problem.</A>=20
<P>After Joy Covey established the principle of EBITMA, =
internet=20
companies began using all types of non-earnings related =
statistics=20
to show growth. Page views, registered users, unique =
monthly=20
visitors are just some of the meaningless examples that =
became=20
popular. (Surely you remember.) =20
<P>When "non-revenue statistics" becoming drivers of stock =
prices,=20
(around 1998) pro-forma earnings increased in popularity. =
After=20
all, a pro-forma income statement that showed <I>some kind =
of=20
earnings</I> progress looked a lot more "real" than the =
phony=20
statistics being coughed up by internet companies. =20
<P>But when the bubble collapsed, <I>everyone </I>began=20
questioning earnings quality. It didn't happen overnight, =
and it=20
didn't happen all at once. But as a long, slow =
evolutionary force,=20
earnings confidence has eroded, and is still present =
today. =20
<H3>The Aftermath</H3>The evolution of earnings focus over =
the=20
past 10 years has led us to today's situation: a basic =
lack of=20
confidence in many companies income statements. =20
<P>Amazon.com still reports earnings on a pro-forma basis. =
In=20
their Q1 income statement, you can take your choice of=20
earnings: =20
<UL>
<LI>Pro-forma: $25 million profit =20
<LI>Operating: $2 million profit =20
<LI>Net (as-reported): $(23) million loss =
</LI></UL>The=20
earnings format <I>you choose</I> is not relevant, =
frankly. It is=20
far more important to the stock value what format <I>the =
guy next=20
to you chooses.</I>=20
<P>After all, value <I>to you</I> is primarily determined =
by what=20
someone else will pay, not by what you pay. =20
<H3>Even GE</H3>Even solid companies like General Electric =
have=20
come under scrutiny because of the extremely complex =
financial=20
situations. Unraveling a GE earnings report has now become =
a major=20
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=20
not enough. =20
<P><I>GE stock is down 50% in the last two years despite =
having=20
only missed one earnings estimate in the last four years =
and=20
having continual year-over-year growth in earnings =
averaging=20
15%. </I>=20
<P>This bears repeating: GE, as representative a stock as =
you can=20
get of the overall economy, is down 50% since September =
2000.=20
During that time period, they have grown earnings at over =
11%=20
(year-to-year basis) and beat or met earnings estimates =
every=20
quarter except one. The one shortfall was October 2001, =
the=20
quarter of the Attack on America and GE was only one penny =
short. =20
<P>Why can't GE get any respect? The only definable =
long-term=20
culprit is a decline in confidence in GE's earnings =
numbers.=20
During the same eight quarter time-period, GE revenue =
growth rate=20
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 for most of 2001. =20
<P>Flat or declining revenue combined with continuing =
increasing=20
earnings leads to only one conclusion: <I>you can't keep =
this up=20
forever. </I>Eventually, GE will be unable to book the =
earnings=20
number higher than previous years. When (if), that =
happens, GE=20
stock will be further devastated. Until then, the slow =
erosion of=20
confidence causes the stock price to decline. =20
<P>GE is just one good example of how confidence in =
earnings=20
numbers has been eroding over time since the bubble =
collapse.=20
Until greater confidence in earnings numbers is =
established, you=20
can expect further difficulties in the market =
overall. =20
<P>Standard & Poors is now pushing for a standardized=20
calculation for earnings reporting, called Core Earnings. =
We will=20
have more on this concept in Part II of this story, to =
appear=20
later this week. =20
<P>Comments may be emailed to the author, Robert V. Green, =
at <A=20
=
href=3D"mailto:rvgreen@briefing.com">rvgreen@briefing.com</A><!--(RVG)-->=
</P></TD></TR></TBODY></TABLE>
<BLOCKQUOTE=20
style=3D"PADDING-RIGHT: 0px; PADDING-LEFT: 5px; MARGIN-LEFT: =
5px; BORDER-LEFT: #000000 2px solid; MARGIN-RIGHT: 0px">
<DIV style=3D"FONT: 10pt arial">----- Original Message =
- -----</DIV>
<DIV=20
style=3D"BACKGROUND: #e4e4e4; FONT: 10pt arial; font-color: =
black"><B>From:</B>=20
<A title=3Dwlittle1@peoplepc.com=20
href=3D"mailto:wlittle1@peoplepc.com">Winston Little</A></DIV>
<DIV style=3D"FONT: 10pt arial"><B>To:</B> <A=20
title=3Dcanslim@lists.xmission.com=20
=
href=3D"mailto:canslim@lists.xmission.com">canslim@lists.xmission.com</A>=
</DIV>
<DIV style=3D"FONT: 10pt arial"><B>Sent:</B> Friday, June 28, =
2002 9:47=20
AM</DIV>
<DIV style=3D"FONT: 10pt arial"><B>Subject:</B> Re: [CANSLIM] =
Now=20
Xerox?</DIV> They all used EBITDA.. which Warren Buffett =
in May=20
said is the currency of a <BR>crook ... they all have a smell =
about=20
them.=20
<P>----- Original Message ----- <BR>From: "Kelly Short" <<A =
=
href=3D"mailto:kelly.short@neoris.com">kelly.short@neoris.com</A>>=20
<BR>To: <<A=20
=
href=3D"mailto:canslim@lists.xmission.com">canslim@lists.xmission.com</A>=
>=20
<BR>Sent: Friday, June 28, 2002 9:46 AM <BR>Subject: [CANSLIM] =
Now=20
Xerox? <BR> =20
<P>Enron, WorldCom- nothing. Xerox off by $6B. (Yes- that's =
"B" as in=20
boy!)=20
<P>Kelly <BR> </P></BLOCKQUOTE></BLOCKQUOTE>- -To=20
subscribe/unsubscribe, email "majordomo@xmission.com" -In the =
email body,=20
write "subscribe canslim" or -"unsubscribe canslim". Do not use =
quotes in=20
your email.</BLOCKQUOTE></BLOCKQUOTE>- -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.=20
</BLOCKQUOTE></BODY></HTML>
- ------=_NextPart_000_000A_01C21ED6.0D059720--
- -
- -To subscribe/unsubscribe, email "majordomo@xmission.com"
- -In the email body, write "subscribe canslim" or
- -"unsubscribe canslim". Do not use quotes in your email.
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