Operating earnings hide US economic downturn

Companies normally have 3 ways of pleasing investors:

• Meet or better expectations for revenue and earnings
• Cut costs to meet earnings if revenues disappoint
• Focus attention on a more favourable earnings definition

When things are going well, the first option is preferred. But under the pressure of a sustained economic downturn, it is understandable that some companies might investigate other options.

According to Paul Marson in the Financial Times, the third option is very popular at the moment. More companies than ever are focusing attention on ‘operating earnings’ rather than ‘reported earnings’. These sound much the same, and ‘operating’ even seems more ‘hands-on’ than ‘reported’.

But ‘operating’ earnings allow companies to exclude items that have to be included in ‘reported’ earnings, under GAAP accounting standards. And Marson notes the gap between the two is now at an all-time record of $54/share. Today’s ‘reported earnings’ for the S&P 500 companies are just $7.20/share, versus $61.20/share ‘operating earnings’.

US retail Aug09.jpg

Of course, if recovery were just around the corner, then companies might be right to highlight this to investors. But there is little evidence to support this argument: last month’s US retail sales were down 8% versus 2008, and even retail giant Wal-Mart saw a 4% decline, reporting that “customers around the world are forced to do more with less”.

Leading retailers such as Wal-Mart are an excellent leading indicator for the world economy. And as US head Eduardo Castro-Wright noted, the outlook is weak as “more people are concerned about unemployment”.

In fact, Q2 saw many companies following Wal-Mart’s reaction to falling sales revenues by taking the second option of cutting costs. In turn, of course, this creates a vicious circle by increasing unemployment.

At the same time, US foreclosures continue to climb. July’s record volume saw 360k properties receive a foreclosure notice last month – a scary 1 in every 355 households. And of course, the consumer accounts for c70% of US GDP, and 16% of total global output. So a problem for the US consumer is a problem for the global economy.

Budget season is about to start, when chemical companies start to take a view on the outlook for 2010. Although the blog would like to be optimistic, it doubts that the optimistic view portrayed by ‘operating earnings’ is reliable evidence of a real recovery in the US economy.

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. He also serves as a Global Expert for the World Economic Forum. The aim of this blog is to share ideas about the influences that may shape the chemical industry and the global economy over the next 12 – 18 months. It looks behind today’s headlines, to understand what may happen next in critical areas such as oil prices, China and Emerging Markets, currencies, autos, housing, economic growth and the environment. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.

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One Response to Operating earnings hide US economic downturn

  1. Adam 19 August, 2009 at 5:58 pm #

    Nice post. I recently charted the gap between operating and GAAP earnings for the last 21 years. It’s pretty telling:


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