It's second-quarter earnings season, and all eyes are glued to the quarterly reports. Last year at this time, only about half the companies in the Standard & Poor's 500 stock index showed revenue growth. This year so far, more thanthree-quarters are showing increasing revenues --evidence that the nation's economic prospects have brightened. The good news may justify the nearly 10 percent rise in the Dow Jones Industrial Average so far this year.
That is, if you believe what's in the earnings reports. But beware. Despite allthe new laws, rules, lawsuits and headlines over the last year, earnings reports continue to overstate corporate income.
First, they still don't include employee stock options. But by any real-world understanding of corporate balance sheets, stock options are expenses. And the SEC's and Congress's unwillingness so far to require companies to treat them assuch exaggerates corporate earnings. Without knowing the value of stock optionscompanies have given their employees, it's hard to figure out how companies arereally doing and how one company compares to another.
Second, many companies are also inflating the returns on their corporate pension plans. Or they're hiding their true pension burdens by assuming artificially high rates of return on their pension investments. Accounting rules still allow them to do this -- even though the reality is that a lot of pension plans these days are in deep trouble after three years of a declining stock market and historically low interest rates.
So what are corporations really earning? A team of respected analysts from UBS-- the former PaineWebber -- concluded in a recent report that -- and I quote -- "the quality of earnings for the S&P 500 from an accounting standpointis the worst it has been in more than a decade." Now, that's saying something.
Poor quality from an accounting standpoint means, in effect, there's less good news than meets the eye.
All of the enforcement actions against corporate fraud mean very little if accounting gimmicks are still legal. Earlier this week, the nation's two largest banks -- J.P. Morgan Chase and Citigroup -- agreed to pay a big fine tosettle accusations that they aided Enron when they lent money, knowing full well that Enron was up to no good. Presumably, big lenders will now be more careful. But if companies are still allowed to use accounting gimmicks -- such as not including employee stock options on on balance sheets, and overstating returns on their pension investments -- it won't matter whether big lenders arecareful or not.
After everything we've been through over the last year and a half, isn't it time to close these loopholes and make sure corporate earnings reports actuallymean something?
