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Selective Reality

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Posted by: Jack Ciesielski	7/18/2005 6:04 AM
Back from vacation. Yet the world did not change! While away, I still read the paper, of course. And last Tuesday, I was disappointed - but not surprised - by what Diya Gullipalli wrote in the "Tracking the Numbers" column of the WSJ. (Subscription required. Get one if you don't have it!) Her article was a review of the Babel-esque language being used on Wall Street when it comes to the mother tongue: earnings. And what's Babelizing it is the way different folks are looking at option compensation expense. Of course. Calling compensation by its proper name will lower earnings. And some folks won't like that, and will insist on the good old way of reporting (no reporting, that is) when it comes to looking at earnings forecasts. From the article: "It isn't just corporate chieftains whom they are seeking to appease: Many mutual-fund managers and other Wall Street trading clients prefer the higher per-share figures, too, analysts say, fearing the lower earnings forecast that would result from factoring in options would ding the stocks they already hold." Nothing revelatory there: where self-interest is at stake, denial is always an option. But what's most disheartening is that those who stand to benefit in the long run from clean reporting of compensation are part of the resistance to it. Also discouraging: nobody is showing enough guts to do the right thing and where possible, demand that fully-loaded earnings estimates are presented. The article quotes one representative of a major Wall Street institution referring to the mixed investor preference as a "client issue." Another declared, "We're in the client-service business, and the majority of our clients tell us they prefer a pro forma number without the options impact in there." It would be hopelessly naive to expect that Wall Street research analysts are in the research business, I suppose. If they were, perhaps as experts they'd be able to persuade their clients as to the right way to evaluate performance reporting. Better to keep the client satisfied; tell them their clothes are perfect, even when they're naked. The article mentioned that several firms are requiring their analysts to present their earnings estimates with stock option compensation expense within a certain time frame - but at least one of them qualifies their plan with the statement that it will be a requirement as long as it doesn't get their estimates "excluded from the consensus measures." Which leads to another example of damnable spinelessness. The article mentions that the big earnings estimate warehouses - Thomson Financial First Call, Reuters Estimates, and Zacks Investment Research - are going with the flow and reporting as consensus as whatever basis the majority of analysts use in their estimates. They abdicate any responsibility for "enforcing accounting rules." Yet their services are premised on presenting estimates that have been presumably accounted for in the same way. If all the analysts in say, the tech sector, have been brainwashed into preparing their estimates without option compensation expense, but all the analysts in the capital good sector present their estimates on a full-cost basis, of what use is the data in the warehouse? It's surely not going to permit earnings jockeys to make useful inferences across sectors. Open note to all EPS clearinghouses: justify your prices. No one's asking you to "enforce accounting rules;" just suggesting that you make your data consistent so that it's worth more to your clients. Is ANYONE in charge here? The FASB has decided - again - stock compensation is an expense. (And it always was.) So far, the SEC supports them. There's obvious resistance to the reality from the quarters you'd expect - the tech sector. But don't expect much counter-resistance from Wall Street and their data suppliers until it's clear which side their bread is buttered.

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