The recent spate of writeoffs by major firms like AT&T Corp., Cisco Systems Inc., Lucent Technologies Inc., Nortel Networks Inc., Walt Disney Co., and Wells Fargo Inc. calls into question the lofty profits of the 1990s, says the Wall Street Journal.
Since the economy began to slide in the fourth quarter, S&P companies have announced write-offs and other “special” charges of about $50 billion, according to data provided by Multex.com Inc., a financial-research company. That total for the six months ended March 31 is the highest dollar amount by far for any recorded six-month period and the second-highest as a percentage of pretax income since 1992. And the trend is expected to continue as companies release their second-quarter earnings in coming days and weeks, says the Journal.
The sheer size of these write-offs has ignited a debate among economists and Wall Street analysts about whether there is a connection between today’s big write-offs and yesterday’s massive profits, says the newspaper. The question is whether some of the outsize profits rested on shaky business and accounting practices that are now in effect being restated by big charges.
For example, when a company writes off a multimillion-dollar loan that it made to finance sales to a start-up customer, some investors view that as a one-time reduction of the most recent quarter’s earnings that can be shrugged off. Others see such a charge as a tacit admission that profits in prior quarters — when the sales and earnings generated by those loans were recorded — weren’t as large as the books show.
That’s not to say that companies announcing large charges today were recording past profits in violation of generally accepted accounting principles, or GAAP, says the Journal. And not all of the recent charges reflect management missteps. Some of the biggest write-offs — such as those related to layoffs and the restructuring of divisions — appear to stem directly from the sharp economic decline that began in the fourth quarter of 2000, which many executives say couldn’t be foreseen. Indeed, write-offs typically accelerate during economic downturns, especially in times of rapid technological advances.
Still, the idea that prior profits have been overstated helps economists explain what to them was one of the mysteries of the late 1990s. Generally, corporate profits have grown in line with the economy. For the past five years, however, S&P 500 profits have expanded about twice as fast as the economy’s total economic output, says the newspaper.
But those S&P profit figures, which are the ones Wall Street mainly cares about, don’t include the recent spate of unusual charges. Exclude the write-offs, as many analysts do, and pretax earnings for the current group of S&P 500 companies during the five-year period ended March 31 grew at a compounded annual rate of 9 percent. Restore the unusual charges as normal expenses, and the rate falls to 7.6 percent. That’s closer to the recent compounded annual growth rate of the economy as a whole over the period — about 6%, including inflation, says the Journal.
The government’s corporate-profits measure, a far broader gauge that accounts for these unusual items and includes both closely held and publicly owned companies, shows much more modest compounded annual earnings growth of just 4.4 percent over the past five years.
It’s easy to see how the spate of charges can create confusion among investors trying to figure out which numbers to follow. If today’s charges do, in effect, eliminate past profits, a simple calculation such as a price-to-earnings ratio can become a complex exercise because it’s difficult to gauge how much companies really earned, says the Journal.
In response, officials at the Securities and Exchange Commission recently have criticized the growing practice by many companies of issuing news releases that highlight earnings excluding these unusual charges, called “pro forma” earnings, while playing down their GAAP earnings. The commission has opened investigations into a few companies, which it declines to name, over whether their pro forma results have been misleading, according to the Journal.
In some ways, the willingness of so many other analysts and investors to disregard today’s charges is a sign of the times. Wall Street has placed revenue and earnings growth on a pedestal. What has emerged is a culture in which many investors reward companies for big write-offs, viewing the charges as bad news that executives have pushed out of the way to make room for high future growth rates, says the Journal.
The newspaper reports that the most common types of writeoffs are vendor financing, portfolio losses, inventory, goodwill, and stock instead of cash payments from customers.