- Stocks are getting more expensive, meaning there could be a greater risk of stocks falling if the earnings figures being used to justify buying them are questionable. One measure of how richly priced stocks are suggests trouble. Three years ago, investors paid $13.50 for every dollar of adjusted profits for companies in the S&P 500 index, according to S&P Capital IQ. Now, they're paying nearly $18.
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In a crackdown after the dot-com crash, regulators required companies to lay out clearly in their financial reports how they arrived at alternative versions of their profits. The bottom-line figures have to be prominently reported, too. But it's not clear the extra details have helped.
"The data is more confusing than it's been in a long time, and the reason is all the junk they put in the numbers," says fund manager Michael Lewitt of the Credit Strategist Group. He says analyst reports don't help, and finds himself spending too much time sifting through the same "nonsense" figures he confronted back in the dot-com days.
Michelle Leder, founder of Footnoted.com, which produces detailed analyses of financial statements, says most investors don't even bother to sift, preferring instead to seize upon a single number, often the wrong one.
"People just want to know the number," she says. "They don't care how the sausage is made."
Boston Scientific, a maker of medical devices like stents used to prop open arteries, had adjusted profits of $3.6 billion in the five years through 2014, according to analysts' calculations. But if you include a write-off for a failed acquisition, various "restructuring" charges and costs stemming from layoffs and lawsuits, it's a different picture entirely: $4.9 billion in net losses.
In a brief talk to analysts in April, the chief financial officer at Boston Scientific used the word "adjusted" in referring to results 34 times, twice every minute, on average. The word is also littered throughout the company's presentations and financial reports. In recent years rivals Medtronic, Stryker and Zimmer have also highlighted their results this way, says Raj Denhoy, an analyst at Jefferies, an investment bank.
Aluminum giant Alcoa has taken "restructuring" and related charges in 20 of the past 21 quarters. The company reported net losses of more than $900 million in the five years through 2014, but analysts have largely shrugged them off because they're tied to a strategic shift that involves getting rid of unwanted businesses. Analysts prefer to point to the $3.1 billion in adjusted profits during that time.
To be fair, analysts see the adjusted figures more as a tool for helping estimate future profits than as a judgment on the past. They say many losses and charges are not likely to recur and shouldn't be included in their calculations.
But in an age of constant change, when some companies revamp their business repeatedly, many one-time items are starting to seem not so one-time anymore.
"If you have to reinvent the company every couple of quarters, then it's not a one-off," says accounting expert Jack Ciesielski, longtime publisher of The Analyst's Accounting Observer, a newsletter.
What to count
For their part, Boston Scientific and Alcoa say the extra figures they provide help shed more light on their companies. Boston Scientific says the numbers allow investors to see the company "through the eyes of management" because they are the same ones its executives use in making decisions. Alcoa says its financial results reflect a "significant transformation" to make it more competitive.
Another number often missing in adjusted profit figures is the value of stock awarded to employees. This stock-based pay, the argument goes, requires no exchange of cash, so it doesn't affect a company's earnings power. Critics say stock distributions are a part of compensation and should be counted as an expense.
"What if they said they're going to pay for rent by issuing stock?" asks Brown of Second Curve Capital. "Would you then (exclude) rent" in calculating earnings?
Salesforce.com, a leader in cloud computing, routinely excludes the cost of stock compensation from figures it touts to investors, and analysts largely do the same. Analysts say the company earned $1.2 billion in adjusted profits in the five years through 2014. Its bottom-line result, including stock pay and other costs, was a $712 million loss.
Brian Rauscher, chief portfolio strategist at Robert W. Baird & Co., says stocks can continue to rise based on an inflated account of company profits for months or even years, but not indefinitely. He says it's like a bomb no one can see has been placed under the market: You know it's there, but you're not sure when it will go off.
"We don't know if the fuse is a few inches or a few miles," he says.