EPS targets

EPS (Earnings per share) is a commonly cited performance measure. Trouble is, it doesn't tell us that much. Recently, CSL Ltd effectively tripled its earnings per share by undertaking a 3 for 1 share split. Nothing about the future performance (cash flow or overall earnings) changed. Paul Kerin points out how managers focused on increasing EPS can do two bad things: (1) undertake investments when they shouldn't, and (2) not undertake investments when they should. So, what's a better measure? Kerin argues that we should focus on "cash and strategic logic". If you're looking for an overall performance measure, then Return on Equity (ROE) or Return on Assets (ROA) are going to be better than EPS, or EPS growth.

BHP / RIO

There will be masses of words written about this. The whole process is going to take some time. Here's a starting point: Bryan Frith.

Earnings quality / pro forma earnings

Here's an oldie but a goodie. Businessweek from 2001.
Key graphs:

Sometimes, as in the case of Enron, fuzzy numbers result from questionable decisions in figuring net earnings. More often, though, the earnings chaos results from a disturbing trend among companies to calculate profits in their own idiosyncratic ways--and an increasing willingness among investors and analysts to accept those nonstandard tallies, which appear under a variety of names, from "pro forma" to "core." (Enron offers its own such version. Before investors untangled the importance of Enron's first announcement, its stock rose briefly because it told investors that its "recurring net income" had met expectations.) The resulting murk makes it difficult to answer the most basic question in investing: What did my company earn?

Why calculate a second set of earnings in the first place? Because the numbers reached by applying generally accepted accounting principles (GAAP) are woefully inadequate when it comes to giving investors a good sense of a company's prospects. Many institutional investors, most Wall Street analysts, and even many accountants say GAAP is irrelevant. "I don't know anyone who uses GAAP net income anymore for anything," says Lehman Brothers Inc. accounting expert Robert Willens. The problem is that GAAP includes a lot of noncash charges and one-time expenses. While investors need to be aware of those charges, they also need a number that pertains solely to the performance of ongoing operations.

That's what operating earnings are supposed to do. But because they're calculated in an ad hoc manner, with each company free to use its own rules, comparisons between companies have become meaningless. "No investor--certainly not any ordinary investor--can read these in a way that's useful," says Harvey L. Pitt, chairman of the Securities & Exchange Commission. The SEC is examining whether new rules are needed to clarify financial reports and perhaps restrict use of pro formas.

What's badly needed is a set of rules for calculating operating earnings and a requirement to make clear how they relate to net income. In the end, investors need two numbers--a standardized operating number and an audited net-income number--and a clear explanation of how to get from one to the other.

Excessive pay deal?

John Durie on the back page of The Oz puts forward a suggestion: if the Telstra board ignores the vote against the proposed executive pay package (see SMH discussion here, then the logical step is to vote out the board. Heh. Let's see if the government (or the Future Fund) are prepared to do that!

Sub-prime stupidity

Dennis Berman in the Wall Street Journal calls it like it is.

The subprime realm has thus become a vital portal onto Wall Street, helping us understand just how upside-down the place has become. In this world, risk management is applied retroactively. CEO succession planning is, too.

Don't let those on Wall Street fool you by saying "this is the natural cycle of things." Does it really have to be? Unlike virtually any other industry, Wall Street shakes, twists, and hammers on its innovations until they break. What would happen if Boeing Co. or Johnson & Johnson rolled out products with similar defect rates?

Credit rating agencies / subprime / Citigroup

Still more on credit ratings. Turns out the mathematical models used by banks such as Citigroup to value securities like the securitized (sic) subprime mortgages (CDOs, or collateralised debt obligations) relies heavily on credit ratings. That led to the situation where (as we've discussed in class) a downgrade by a ratings agency becomes somewhat self-fulfilling. Wall Street Journal "Heard on the Street" article (via the Oz) here . [Note: this is one of the early benefits of News Corp buying Dow Jones. The Australian gets access to the Wall Street Journal. Goodbye AFR?

Pressure on security analysts

Do analysts ever wonder about the consequences of downgrading their recommendation on a firm? What if it's death threats? Yep. I think the analyst made the right call. As long as they're not, you know, actually killed.