In an effort to improve the quality of its research, Merrill Lynch has issued an internal memo telling its stock analysts to use a variety of metrics to gauge the state of companies' financial performance, rather than relying on pro-forma earnings. According to the Wall Street Journal, the memo is part of a project to develop and define internal standards for analyzing financial performance.
Under the new standards, Merrill analysts will focus more on earnings prepared according to generally accepted accounting principles (GAAP). These earnings will be used as a basis for GAAP-based analytical techniques, such as comparisons of cash flows with net income. The firm will also focus on key ratios, such as return on capital and return on assets, and balance sheet measures, such as the levels of receivables and inventories.
Although many firms on Wall Street say their analysts look beyond pro-forma earnings, Merrill may well be the first big investment firm to adopt formal standards. "I don't know of anyone else who has gone that far," Nina McKenna, a former chief regional counsel with the enforcement division of the National Association of Securities Dealers, told the Wall Street Journal. Arthur Levitt, former Securities and Exchange Commission chairman is quoted by the Journal as saying, "I think it's a good approach," Mr. Levitt said. "It begins to address the issue of managed numbers."
Shortly after the memo was released, according to Bloomberg news service, Merrill Lynch analyst Peter Goldmacher issued a research report entitled "Good Riddance to Pro Forma Pro Rata,'' to announce that he will be switching to GAAP-based analytical metrics.
Merrill's standard-setting project is being led by its chief of equity research, Deepak Raj. Mr. Raj said the project still is being developed, but the firm hopes to have standards in place in time for the second-quarter earnings season.