Corporate Earnings

Bean Counter Uprising!

By, 05/14/2007

We've written before in this space on the complexities and absurdities of today's accounting systems. Here's another taste of the insanity: reported year-over-year Q1 earnings growth for S&P 500 companies (so far) is 8.5% according to Thomson, Bloomberg has first quarter earnings growth at 13% using their own proprietary methodology, and S&P focuses on operating earnings with the most recent report (on 4/27) indicating earnings up around 7%. (Incidentally, just about any which way you look at earnings, they're easily beating forecasters' lowered expectations so far this quarter.)

Clearly, these are big differences in the calculated strength of earnings. Whose numbers are right? It all depends on what accounting methods you like and which numbers you think are truly relevant. Operating or net? EBIT or EBITDA? These are difficult questions, but what should be clear, though, is earnings strength is more a matter of subjectivity than hard empirics. Accounting standards themselves, at least in the sense they endeavor to "explain" the profitability and financial health of a company, are something of an illusion. Accounting has its own schema of logic that often corresponds only to itself for coherency, and not the real world.

To the credit of those who oversee standard accounting practices, attempts are being made to change things. For today's mostly service-based US economy, which uses an accounting system essentially founded during the industrial revolution, well, it's probably time for a change.

Today's big push is for increased global accounting standards, and the FASB is set to propose some of the most radical changes ever later this quarter. Net income could be eliminated; even the basic notions of assets and liabilities on a balance sheet could be altered forever. This, of course, is causing distress among investors. Here's a full report:

Profit as We Know it Could Be Lost With New Accounting Standards
By David Reilly, The Wall Street Journal (*site requires registration)

This is nothing to fret over. Sure, there probably will be some economic deadweight loss in retraining people to new methods; and yes, many investing hobbyists and their respective weekly investing clubs will be probably be confused for awhile. But the effects will be minimal to stock markets.

What stabilizes and strengthens markets is information, not methods of accounting. What matters most is the availability of information to the investing public. From there, markets will determine for themselves the truth, not the FASB.

Ultimately, greater standardization is probably a good thing. The ability to compare companies the world over on a consistent basis will be undoubtedly useful on some level. This most likely will mean greater availability and breadth of information from international companies. But we expect no adverse stock market reaction should big changes arrive.

Let the bean counters have their revolution—stocks won't mind a bit.

Sources: Standard & Poors, Bloomberg, Thomson

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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