In a study described as a “sad commentary on the state of financial reporting in the United States,” SmartStockInvestor.com analyzed the earnings (or losses) of the top 100 companies on the technology-heavy NASDAQ Exchange for the first three quarters of 2001.
The study found the use of pro forma reporting turned combined losses of $82 billion for these companies under generally accepted accounting principles (GAAP) into combined profits of $19.1 billion. Just as startling, four of the five largest NASDAQ companies (by market capitalization) had combined profits under both bases. But their pro forma earnings were nearly five times their GAAP earnings.
Effects on Ratio Analysis
The author, John J. May, explains that pro forma earnings are used to calculate the earnings per share (EPS) and price earnings (PE) ratios reported by popular online services, such as Thomson Financial/First Call and Yahoo Finance. In defense of pro forma earnings, he notes that a full year 2001 PE ratio based on GAAP earnings would probably be meaningless since full year results are likely to be negative (losses) rather than positive. But, the downside is the unexpected surprises often referred to as the bursting of the bubble. While pro forma earnings helped buoy stocks in the short term, Mr. May says, the “deceptions” ended badly.
Waiting for the SEC
“Sooner or later,” says the author and head of SmartStockInvestor.com, “the Securities and Exchange Commission (SEC) will be forced to fulfill its mission of preserving the integrity of financial reporting in this country and investors will be amazed at how much they’ve been duped in recent years.” Mr. May is a CPA/MBA and a former Big Five auditor.