S&P creates new method to calculate earnings

NEW YORK — Responding to deepening skepticism about the way many companies report financial performance, Standard & Poor's unveiled a new benchmark yesterday designed to gauge corporate earnings more accurately.

Under the new "core earnings" measure, the 10,000 U.S. companies analyzed by S&P will have some revenue they use to boost profits — such as pension-fund investment gains — stripped away.

The lucrative stock options that corporations typically grant executives will be deducted from per-share earnings to provide a better yardstick of executive costs.

The new way to assess company earnings comes amid investor dismay over revelations — many prompted by the Enron scandal — that publicly traded corporations have used questionable accounting methods in their quarterly and annual reports to inflate profits and mask costs.

S&P officials said their changes will benefit small and institutional investors alike. The purpose is to provide a clearer picture of revenues and costs associated with companies' primary businesses.

"If nothing changes, investors will lose more and more faith in the stock market," said David Blitzer, S&P's chief investment strategist. "They're going to start putting their money somewhere else."

He said S&P wants to improve the reliability of earnings information, which has taken a huge hit over the use of "pro-forma" earnings numbers that exclude certain costs.

Pro-forma earnings came into vogue in the 1990s, especially with Internet companies that made sometimes wild predictions on earnings possibilities. Those predictions proved unfounded when the Internet bubble burst in 2000. Still, pro-forma earnings remain popular.

The new standards will be used first to calculate figures for the S&P 500 index of large U.S. companies and other S&P indices, and eventually will apply to all the companies S&P rates.

S&P also will use the core-earnings method to help set its corporate-debt ratings, a key measure of the risk companies pose for investors.

While S&P can't force companies to use the new standard, stock analysts are expected to use the measure to evaluate whether investors should buy or sell stock.

S&P President Leo O'Neill said S&P officials won't lobby for the measure to be mandated by regulators but are willing to discuss the system with the Securities and Exchange Commission and the Financial Accounting Standards Board, which set corporate accounting rules.

Under the new standard, price-to-earnings ratios will rise for most companies and for the S&P 500, adding to worries the stock market is overvalued.

Price-to-earnings ratios, or PE ratios, are calculated by dividing a company's per-share price by its earnings for the latest year. The higher the PE ratio, the more investors are paying to buy shares.

For example, General Electric's per-share earnings for 2001 were reported at $1.41 excluding an accounting charge, but S&P calculated the conglomerate's core earnings at $1.11 — a 21 percent difference.

S&P chopped 30 cents off per-share earnings primarily to account for pension-fund gains that were included in the earnings statement and stock-option grants that weren't. The change lifted GE's PE ratio from 28 to 36.

S&P's core-earnings measure will also include writedowns of depreciable assets, purchased research and development and pension costs. Items to be excluded include gains and losses on asset sales, unrealized gains or losses from hedging activities, fees related to mergers and acquisitions and legal settlements.

The method probably won't affect stock prices, said Chuck Hill, of Thomson Financial/First Call. Many professional stock analysts, he noted, already make calculations about companies using the factors S&P will use. Hill said the new standard could muddy the waters for investors because it hasn't been endorsed as a uniform measuring tool.

SEC wants fund ads to give access to current data

WASHINGTON — The Securities and Exchange Commission yesterday proposed rules to require that mutual-fund ads contain information on how to get current figures on a fund's performance and expenses.

Many ads use impressive performance figures that may be years old. Under the proposal, funds that use dated figures must display the time period more prominently. Investors and Congress have complained that funds hyped performance during the dot-com boom of the late 1990s and failed to adequately disclose expenses to investors.

The SEC requires fund advertising to include returns for one-, five- and 10-year periods that are current to the end of the most recent quarter. The proposal would require fund ads to direct investors to the most recent month-end figures, using a toll-free or collect telephone number or a Web site.

— Bloomberg News