A Word From Bob

As Seen & Heard

Contact Us

rss

Invest Yourself

The FREE Investment Newsletter That Really Works!

10.12.2014 Financial Intelligence Report Bookmark

Earnings Upon Us…

Four times a year, most companies produce their economic report for the previous quarter of business. This isn’t something new, they’ve been doing it since the idea of a structured company first began. But like most things, they’ve “morphed” into something much different than the standards set so many years ago. I’m not shy in saying that a very competent accountant overseeing companies in 1920 would have absolutely no clue how to figure out what the hell any modern company was even talking about.

So when these companies start releasing their earnings in bulk next week, just what are we actually hearing them tell us? Sometimes it isn’t as easy as just saying “oh that’s their earnings based on sales versus expenses”.  Thus I think a bit of history lesson needs to be taught here….
Earnings Upon Us…

Four times a year, most companies produce their economic report for the previous quarter of business. This isn’t something new, they’ve been doing it since the idea of a structured company first began. But like most things, they’ve “morphed” into something much different than the standards set so many years ago. I’m not shy in saying that a very competent accountant overseeing companies in 1920 would have absolutely no clue how to figure out what the hell any modern company was even talking about.

So when these companies start releasing their earnings in bulk next week, just what are we actually hearing them tell us? Sometimes it isn’t as easy as just saying “oh that’s their earnings based on sales versus expenses”.  Thus I think a bit of history lesson needs to be taught here….

There have been “company’s” for hundreds of years. They also sold stock in those companies, although it was quite different than what we know today. For instance the East Indian trading company of the early 1700’s. The East India Company originally chartered as the Governor and Company of Merchants of London trading into the East Indies; and more properly called the Honourable East India Company (HEIC), was an English, and then later (from 1707) a British joint-stock company.

You could literally buy “shares” of the ships loads, and actually the original silver “piece of eight” was a way folks would buy an eighth share of a particular load.  So the idea of stock ownership goes way way back. But the problem was that if you wanted to be an investor in these companies you had no real idea of what they were worth. They appeared to be worth what the owners said they were worth and that’s that. That kept a lid on “investing” in those early years.

During the Industrial Revolution, as America’s transportation links were being forged, railroad companies pioneered standardized financial reporting to attract public and private capital for projects. Companies reporting clear, comparable and reliable financial information to investors produced an influx of capital investment that led to a revolution in the way that goods were brought to market – and to unprecedented economic growth.

But because companies were still doing their own paperwork and inside calculations, often they were inflated as to their assets, cash, etc. ( Ya think??!!)  The pivotal economic event of the early 20th century; the Great Depression, focused the U.S. on the need for comprehensive accounting reform. Many market participants felt that bogus accounting and reporting procedures helped cause the crash. In 1930, the American Institute of Accountants (known as the AICPA since 1957) and the New York Stock Exchange began an attempt to revise financial reporting requirements. Shortly thereafter, passage of the Securities Act of 1934 chartered the Securities and Exchange Commission, and gave the SEC the power to oversee accounting and auditing methods.

By the 1970s, market participants’ started thinking about more concrete standards, as they came to believe in the importance of an independent standard-setting structure; separate and distinct from the accounting profession—so that the development of standards would be insulated from the self-interests of practicing accountants and their clients. They recommended creation of a new body, the Financial Accounting Foundation, to serve as the nation’s accounting standard-setting authority.

Through the FAF, the FASB in 1973 became the designated organization in the private sector for setting standards that govern the preparation of corporate financial reports along with not-for-profit organizations. The accounting standards developed and established by the FAF’s standard-setting boards, came up with the rules, wording, inclusions, exclusions, etc, that we commonly know as GAAP. Generally Accepted Accounting Practices.  This is about as close to the real health of a company that you’ll ever see.

But because GAAP accounting is pretty hard hitting and spells out the good, bad and the ugly, the cries went up for a way to relax some of those rules. So shortly afterwards they began to work on “Proforma” accounting to “go along” with GAAP reports. Now stay with me here folks, because this is incredibly important.  The term pro forma (Latin for "as a matter of form" or "for the sake of form") is most often used to describe a practice or document that is provided as a courtesy and/or satisfies minimum requirements, conforms to a norm or doctrine, tends to be performed perfunctorily and/or is considered a formality.

Take note of “satisfies minimum requirements” in that definition.  Pro-forma earnings describe a financial statement that has hypothetical amounts, or estimates, built into the data to give a "picture" of a company's profits if certain nonrecurring items were excluded. Pro-forma earnings are not computed using GAAP standards, and usually leave out one-time expenses that are not part of normal company operations, such as restructuring costs following a merger for instance. Essentially, a pro-forma financial statement can exclude anything a company believes obscures the accuracy of its financial outlook.

By the time the late 90’s rolled around and the Dot Com bubble, companies were writing off the most ridiculous things as one time charges. I saw releases where they wrote off wages, electricity, you name it. Explain to me how you can call power a one time event?? You can’t, but the public ate it up and stocks soared. No one looks under the surface when stocks are going up.

After a slight pause in the abusive use of Pro-forma, it’s come back in a big way. Now it’s as perverse as it was in the late 90’s. In fact, when you listen to the earnings reports on most of the financial stations, you’re ONLY hearing Pro-forma reports, reports that have been so doctored up that their own mother wouldn’t recognize them.  If you listen closely you’ll hear something like “XYZ beat their earnings by 12 cents ex-items”… Well there it is. What were those items they proforma’d away?

Companies all too often release positive earnings reports that exclude things like stock-based compensation and acquisition-related expenses. Such companies however, are expecting people to forget that these expenses are real and need to be included. But even those we can overlook a bit. However when they start getting really silly about it, it distorts the entire picture. In Alcoa’s history, we’ve seen them write down reams and reams of supposed one time charges, often charging off more than their yearly accumulated income. Go figure.

My point is this folks… if companies were again forced to only report their true earnings on a GAAP basis, 75% of them would NOT make the estimates. It’s only by way of proforma accounting that they get to make it all so very pretty for us. So, the first issue at hand as we come into the real beginning of earnings season next week is that the numbers you’re going to hear are often Nobel prize winning fiction.

Consider the following random earnings release headlines I’m going to post below, then look for the “catch”.

Alcoa earnings: 31 cents per share, ex-items, vs. expected ... (there’s that ex-items thing. What items??)

Cat CEO: Earnings beat on better US, China growth  With restructuring costs factored in, Caterpillar made a profit of $1.44 a share.  ( restructuring cost them money, but they decided to proforma that out of the equation)

Oracle earnings: 62 cents per share, ex-items, vs. expected ...
El Pollo Loco earnings: 16 cents per share, ex-items, in line ...
EBay earnings: 69 cents a share, ex-items, vs. expected ...
Facebook earnings: 42 cents per share, ex-items, vs ...
Tesla Motors earnings: 11 cents per share, ex-items, vs ...
Hewlett-Packard reports earnings per share of $0.89 ex-items ...

Notice a trend here folks? You bet you do. They all beat their estimates as long as they didn’t have to include those pesky “items” which in any real business is a COST. It goes on the ledger. But if they do that then they miss earnings and the stock goes down and people get grumpy. Not allowed.

Now I’m sure you’re asking “is Bob making this ex-item reporting to be more than it is?”  I can understand that, and the answer is NO. From 207 – 2010 companies “ex-item’d out”, more than 550 BILLION dollars worth of costs just related to the Wall Street melt down.  During that period, Wall Street claimed that the S&P 500 posted cumulative net income of $2.42 trillion. In fact, CEOs and CFOs required to sign the Sarbanes-Oxley statements didn’t see it that way. They reported net income of $1.87 trillion. The difference was accounted for by an astounding $550 billion in corporate losses that were “ex-item’d” right off the ledger.

Well guess what folks? Those costs existed and should have made dents in the respective company’s report and share price. But since that would tarnish the companies shot at insider bonuses and higher stock prices, it just is ignored by the regulators.

That is what we’re going to face this coming week. Made up numbers, fake earnings, written off expenses that shouldn’t be allowed to be written off, you name it. And then folks wonder why I say the market is a rigged fraud. Go figure.  

But you have to understand that as crooked as all this is, everyone plays along with the charade, so markets will move up and companies will get chopped down based on how good a fiction writer the CFO is that day. If he can fudge and fiddle the numbers better than the next guy, the stock is going up, ESPECIALLY if they tie in a huge buy back to their bogus report. That’s the double decker rally monster right there.

Just understand that it’s all fake. The market isn’t up on economic fundamentals; the market is up on Fed money, zero interest rates and the hopes for more punchbowl. Earnings season is a way for a lot of companies to add more punch to that bowl, and no one’s going to question the legality of them. That will come after this market crashes. Until then, we have to play the game.

The Market

Wow. That’s about all you can really say about the action this week. It has been a long long time since we’ve see the chop we’re seeing in this market, when you consider we’re getting key reversal days back to back to back.

The old adage has always been that when a trend is ready to change direction the market will put in a string of very whippy action. Well we’re seeing the very definition of whippy right now. Naturally that gets you thinking that the prevailing trend, which has been “up” for the past 5 years is coming to an end.

However the problem with that thinking is that this market isn’t free. The adage was formed back in a time when there was a separation of investment and commercial banks. A time when Central bankers focused on growth and employment, instead of boosting stock prices. In other words, the adage might not mean much anymore. Times have changed, and this market doesn’t even resemble “normal”.

A couple weeks back, we devoted the entire newsletter to the market. There was no commentary about Ebola, or Libor rigging, or Investment bank frauds, etc. It was all about one topic… the stage had been set for a pretty hefty pull back. I explained all the reasons the warning signs were flashing that we could be looking at our first true 10% correction in over 3 years.

But just the suggestion that they would allow that to happen sends shivers down any newsletter writers’ spine. We had been set up perfectly several times before for a meaningful pull back and it didn’t happen. They’d let the market fall 3 or 4% and then “boom” right back up we’d go, usually setting all-time new highs.  Yet this one felt “different” in a way.

Well we did get a pull back, and as usual it appeared to “stop” when the market was down about 4.5%. That’s when Wednesday we got that insane 280 point bounce and it looked like once again they were going to just let it rip to the upside and take us back to the highs. Well, something happened along the way. Thursday came and instead of following through with a nice green close… we fell like a rock again.  In fact we fell more than 300 points.

Surely on Friday they’d come in a bit and give the market some green right? After a 300+ point fall, wouldn’t it be usual for them to at least get us green by 50 points for the weekend so folks wouldn’t be fearful? Yes that would be what they would usually do. But instead Friday came and the bottom fell out again. We lost another 115 points.  We had fallen 446 DOW points in two days. Wow.

So now we’re at an interesting place. The S&P has fallen to its 200 day moving average. They most assuredly do not want that to fail, because we haven’t dipped below that since 2012. But the DOW is already under its 200 day.  This is getting really interesting.

This week starts earnings season for real. On Tuesday and Wednesday we’re going to get earnings from a lot of the major banking institutions. Will they “make up” enough earnings to make everyone believe that all is well and jam us back up? Or, are we really going to finally see our first real correction, and we’ve got a lot further to fall? This is where being a newsletter writer makes you drink too much. I want to say that we’ve got further to fall. I want to say that this time it is different, and they’re not going to reverse this any time soon and jam us higher.

But just saying that brings out those “shivers”. The market is so manipulated and controlled, and so forced to go where they want it, just thinking that this time they’re not going to rush in and save the day sounds sacrilegious. They’ve done it so many times in the past, anyone calling for a real correction has been the laughing stock of the universe. “Stocks only go up” is the new mantra.
I called for a hefty pullback and we’ve gotten one. From the day I wrote that letter, we’re down 728 DOW points.  The short we put on, the TZA is up 23% for us.  Am I really nuts enough to say there’s more downside coming? Yes but with a caveat. Here’s the deal. They might bounce us some Monday, because the bond market is closed for the Columbus Holiday. They might carry that into Tuesday and Wednesday. But if after hearing the earnings from the financial sector they haven’t really kicked this thing in gear…then yes we’re headed considerably lower. It all depends on those banks and the reaction to them.

For the immediate term, watch that 200 day on the S&P. If that fails, with or without the banks…we’re going considerably lower. To get a real 10% correction…we’d have another 1000 DOW points to go. Wow comes to mind again.





Showing 0 Comment

Social Media

Archive

Bob Recommends