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Stock Ideas Investors Daily Edge The Odds on a Big Bath Earnings Season Rise this Quarter
Stock Ideas Investors Daily Edge The Odds on a Big Bath Earnings Season Rise this Quarter 
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By Chris Johnson Dear Reader, Investors vote their approval and disapproval of the Fed by buying or selling stocks. So last week’s 25 bp cut to key interest rates seems to have disappointed, even though the writing of this outcome was clearly on the wall. It was interesting that the Fed announced a plan to... |
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| The Odds on a Big Bath Earnings Season Rise this Quarter |
| Thursday, 11 September 2008 | ||||||||
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Earnings season is crawling toward us again. Already, unseen accountants are gathering data, verifying numbers, collecting reports, working feverishly. We may not see them work, but we’ll soon hear from them. Alcoa, a Dow Industrials stock, kicks off high earnings season four weeks from now, on Oct. 8. By far the most important part of the whole process is the decisions that management and its accountants will make on how to partition the mounds of data to tell its story. This is especially critical when there is bad news to report. Will it be the big bath, or will it be the small leak? This coming season is a likely turning point. It should be fun for market watchers who like to keep score. For the last two years, earnings season has been a string of ugly reports and gloomy outlooks. Even if the worst is past, there’s little evidence that most American companies are nearing lift-off and will report huge earnings increases and glorious sales outlooks this quarter or next. But they may be looking at much better numbers fairly soon. The consensus is that, there’s more trouble to come. We can anticipate that 2009, at least by midyear, is going to mark a turnaround. Most companies have been releasing the bad news little by little. But now, holding back bad news could mean they push it into a quarter where recoveries will start. And that could undercut the image of progress they will want to create then. Sooner or later, product that hasn’t sold and never will has to be confessed. Sooner or later, those loans and accounts receivable that are hopelessly overdue have to be acknowledged. Those aging plants and stores that need to be closed have to be written off… the cost of casting an ousted CEO into early retirement must be revealed. If a company looks at all the “unusual and non-recurring” problems and decides to take one huge write-off now—the big bath approach—in many cases, the reaction is no worse than it is if they take a smaller write-down. Once the problem is exposed, analysts and smart investors know there’s more to come. So, why not get it all out of the way at once. Everything is supposed to be uphill from there.
Plus, taking one big bath, where a company writes off every loss it can muster, serves an even better purpose. It pushes earnings numbers to the floor, every comparison after that will look like a huge improvement—unless the business really stumbles. In favor of showing a little bit of the problem and doing it slowly is the hope that a little trouble only draws bored yawns amid all the other stories of companies with bigger problems. It is also possible that by the time the next installment of write-offs is due, the business itself has improved so much it overshadows the bad news. These questions go on every quarter, but they have assumed much greater importance recently. Analysts are braced for big write-offs. Pay attention to “operating” earnings this season. That’s because “earnings” come in various flavors. Reported earnings follow GAAP (generally accepted accounting principles). They include write-offs. “Operating” earnings don’t. The difference can be substantial, and it’s probably going to be larger than usual this season. I am bracing for a “big bath” season. But one other thing hinges on these numbers… what exactly is the real P/E ratio when the earnings come in multiple varieties? Lynn P.S. To let me know what you thought of today's article, send an e-mail to: This e-mail address is being protected from spam bots, you need JavaScript enabled to view it
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