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Tuesday, May 24, 2005
Market Recap
The markets were mixed on Wall Street today as the FOMC minutes had no bearing on market movement when released at 2PM EST. They stated that interest rate hikes will continue at a measured pace and that the risk of inflation is high. The market seemed to shrug this news off and the NASDAQ closed higher for the eighth consecutive day. The NASDAQ gained 4 points while the S&P was flat and the DOW lost 19 points. The market is very resilient right now; refusing to drop on what seems to be less than desirable news from the Fed. This market strength has dropped many stocks off of our short watch list and you will notice tonight that I will be removing several stocks from the bulletin tomorrow. I am doing this to cut down on the number of stocks that we are watching in order to concentrate on the very best charts and possible strong movers.
Pro-Forma Earnings
They have found a way to fudge the earnings reports and you should know about it. Some companies are trying to deceive investors with the so-called "pro-forma" modification of earnings. Tonight, I attempt to explain what pro-forma earnings are, when they are useful, and how companies use them to trick investors.
What Are Pro-forma Earnings?
In short, pro-forma is a financial statement that does not reflect write downs or goodwill. Goodwill is the excess of the purchase price over the fair market value of an asset. Accountants record this as a 'write off' in the financial report. This type of accounting trick is used to make earnings look much better. What you should be looking at is net income. Net income is what really determines the profitability of a company.
Sometimes, however, net income does not tell the whole story when a company has one-time charges that are not relevant to future profitability. Some companies, therefore, strip out certain costs that get in the way. By omitting items that reduce reported earnings, this process can make a company appear profitable even when it is losing money. In other words, pro-forma is everything but the bad stuff. Pro-forma earnings are designed to give you a clearer view of a company's operations. The problem is that there is not much regulation of pro-forma earnings, so sometimes companies bend and abuse the rules to make earnings look better. A broker will focus closely on whether or not the company beats or meets expectations and heavens sakes if they miss the number.
How about the average main street investor, its earnings day and a company released its earnings report? Let's say that the company missed its earnings estimate on a non-pro-forma basis but they release the report with the headline stating “they beat the pro-forma expectations”. If all the dumboberry see's is that they beat the estimate, he is going to jump on the stock with the rest of the herd and the stock gaps up at the open. The professional knows the real deal and will short sell the gap. The stock reverses and goes down, leaving all of the amateur investors dumbfounded. They ask “how can the stock go down with that great earnings report?” Answer, it is reported as pro-forma but unfortunately they do not know what pro-forma is. The professionals will dig behind the fluff of the news release and look at the non-pro-forma earnings for the real answers.
Pro-Forma Tricks
Companies all too often release profitable earnings that exclude things like stock-based compensation and acquisition-related expenses. These companies are expecting the average investor to forget that these expenses are real and need to be included. Sometimes companies even take off unsold inventory when reporting pro-forma earnings. That inventory costs money so why should they be able to write it off? It is bad management to produce goods that cannot be sold and a company's poor decisions should not be erased from the financial statements.
Companies are not always dishonest with pro-forma earnings. Pro-forma does not mean that the numbers are automatically being manipulated. However, be skeptical when reading pro-forma earnings because it may save you big money. To evaluate the legitimacy of pro-forma earnings, make sure that you look at what the excluded costs are and decide whether or not these costs are real. Pro-forma is supposed to give investors a clearer view of a company's operations. For some companies, pro-forma makes a lot of sense because of the nature of their businesses, they are constantly writing down big depreciation costs. Pro-forma earnings are informative when official earnings are blurred by large amounts of asset depreciation and goodwill. Intangible things like depreciation and goodwill are okay to write-down occasionally, but if the company is doing it every quarter, it might be time to raise the bull $hit flag.
STHQ Chart Index
If you go to the chart index in the left side menu, you can review and study charts that we have annotated for each stock listed in the past.
For New Members
For all of the new members with us, please make sure to read the link “How to use Bulletin” at the bottom of the Bulletin page on the website. It is critical that you know how to use this trading tool before trying to trade the stocks mentioned. The effectiveness of your trades will diminish if you do not completely understand how the information is presented.
Earnings Calendar
We have added the earnings link for each stock on the bulletin. To access the link for earnings, you can either use the link below or click the link on the bulletin for the corresponding ticker. Click the online bulletin in the left side menu for access to the earning calendar for each stock listed. It is not recommended to hold a position through earnings. You can always buy the stock back after the dust settles.
http://www.earnings.com
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