Jewish World ReviewOct. 1, 2002 / 25 Tishrei, 5763

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Concerns about earnings are justified | It's no surprise that the stock market continues to swing wildly.

Investors are less concerned about war talk with Iraq and the Palestinian-Israeli conflict than they are about plain old earnings. Investors are dealing with another quarter of disappointing earnings - and questions about the quality of those earnings have yet to be answered.

This was supposed to be the quarter that earnings finally rebounded, remember? But so far, the ratio of negative to positive warnings has nearly doubled from the previous quarter. And analysts have scaled back their quarterly forecasts for S&P 500 earnings, too.

It was just five months ago that First Call estimated a nearly 21 percent increase in earnings this quarter. First Call has revised that figure down to only 7.5 percent.

Many Wall Street pros blame the continued sluggishness on the sputtering economy and predict that conditions will improve next quarter. That's encouraging, but where have we heard all this before?

Beside the frustratingly slow rebound in earnings, investors worry about the quality of earnings - and for good reason.

Congress passed accounting - and corporate - reform legislation (the Sarbanes-Oxley bill), but plenty needs to be done to clarify the way companies release financial information. Corporate America is doing better, but none of us knows how much better.

There are still vast disparities in what companies include and exclude from their earnings and when they report them. And companies can still play hide-and-seek on their balance sheets and income statements.

Among others, Standard & Poor's is trying to come up with a better system of financial reporting. Next month, S&P will begin releasing "core" earnings estimates, a much more stringent definition of earnings that deducts the cost of stock options and pension income.

Howard Schilit, founder and president of the Center for Financial Research & Analysis, applauds this move and says that what's really needed is for the Securities and Exchange Commission and the Financial Accounting Standards Board to approve one definitive measure of core earnings.

Schilit also warns that the SEC has yet to deal with a number of transparency issues, including the fact that companies still don't have to reveal the total debt they hold, or say if they have any off-balance sheet partnerships with financial obligation.

Until these changes happen, here are a few of Schilit's suggestions to sort fact from the fiction in financial releases:

  • Pick up a company's latest proxy statement. It gives the credentials of board members. It tells if there are related party transactions, any self-dealing, any loans to executives or an outrageous compensation structure.

  • Spend 15 minutes looking through the proxy. If you're uncomfortable about anything you read, don't own that stock. (Schilit points out that company proxies included Ken Lay's $4 million line of credit and Jeff Skilling's $4 million loan from the company - half of which the company forgave.)

  • Spend 15 minutes looking at the company's cash flow in its financial statement. Simply compare two numbers - the company's cash flow from operations and the company's net income. If the company's net income continues to increase but the cash flow from operations continues to shrink, beware! (Schilit says that for the first half of last year, even though Enron reported more than $1 billion of net income, its cash flow from operations was more than $1 billion in the red.)

The best news of this quarter is that the CEOs and CFOs of 887 of 1,000 companies have certified their financial statements. The bad news is that we won't know for a while just how reliable those statements are.

If you are an investor, the responsibility for evaluating a company and its stock is still yours.

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Lou Dobbs is the anchor and managing editor of CNN's "Lou Dobbs Moneyline." Comment by clicking here.

10/24/02: Business leaders must abandon stall tactics
09/17/02: Wall Street's reality check
09/12/02: There's no better time for leaders to show resolve


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