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It's been more than 18 months since the Sarbanes-Oxley bill passed. Although the legislation was supposed to reform corporate governance and lead to more accountability in the CEO's office, the numbers in quarterly reports remain too confusing and misleading.

According to First Call, fourth-quarter numbers are expected to be a robust 28% better than year-ago figures. What those numbers don't disclose, however, is that earnings at many companies were goosed by the falling dollar, changes in the tax rates and arcane rules that govern pension accounting.

Weak Dollar, Strong Earnings

On Jan. 15,



reported fourth-quarter 2003 earnings from continuing operations of $1.56 a share, up 16% from the fourth quarter of 2002, driven by a 9% increase in revenue. Investors could be forgiven for thinking IBM's growth problems were behind it, considering the company reported 9% revenue growth in the third quarter and a 10% revenue increase in the second quarter.

Not quite. If you factor in the effect of a weak dollar on IBM's revenue for the fourth quarter of 2003, revenue growth drops to 1% from 9%. Revenue booked in a strong overseas currency, say, from a euro-denominated deal in Germany, turns into more dollars on IBM's books if the dollar is falling in value, as it did for most of 2003.

If you remove the effect of the weak dollar on country revenue, IBM's fourth quarter was actually troublingly weaker than the last two quarters. In the third quarter, revenue grew by 4% from the third quarter of 2002 after you correct for the effect of a weaker dollar. That's significantly better than the 1% revenue growth in the fourth quarter.

In the second quarter, revenue was up 3% year over year after correcting for the weak dollar, and in the first quarter, revenue grew by 4%. Revenue growth of just 1% in what is traditionally the strongest quarter for a technology company like IBM certainly should raise a red flag for investors.

But aren't currency gains real earnings? Certainly, and I've argued that investing in companies with big overseas revenue streams is one way to profit from the dollar's current weakness. (Investors have pushed the stock about 5% higher.)

But investors should still take special note when the effects of a weak dollar enable a company to beat Wall Street earnings estimates (IBM delivered fourth-quarter earnings 6 cents above consensus forecasts) while disguising potential revenue weakness in the company's business.

It's one thing for a company like



to report 30% earnings-per-share growth in the fourth quarter when correcting for the weak dollar drops revenue growth for the quarter from 10% to a still-robust 8%. It's quite another situation when correcting for the weak dollar just about wipes out revenue growth entirely.

Higher Earnings, Thanks to Lower Taxes

On Jan. 26,

Texas Instruments


reported earnings of 20 cents a share for the fourth quarter of 2003. That matched the Wall Street consensus projection to the penny. Or did it?

Texas Instruments had told Wall Street analysts that the company would pay taxes at a rate of 26% in the fourth quarter. And that's the number they put in their spreadsheets to come up with their earnings estimates. But as it turns out, thanks to some changes in the company's estimates of its foreign-tax liabilities, the effective tax rate for the quarter came to just 20%. So the drop in the tax rate added about 2 cents a share to earnings, according to Texas Instruments.

If you take tax rates into account, Texas Instruments actually missed earnings estimates for the quarter by 2 cents a share.

Now, I don't think making or missing one quarter's earnings by a penny or two is a big deal. But I don't think investors should ignore the extraordinary tax-rate volatility that's showing up in company earnings reports right now as many companies swing from losses to profits.

Texas Instruments paid a tax rate of 22% for all of 2003 and projects a tax rate of 30% for 2004. In 2002 and 2001, the company showed losses and paid no income taxes. In 2000, it paid taxes at a 33% rate. Take shifts like that into account before you make too big a deal over an earnings surprise. Wall Street caught on. The stock dropped 6.1% between Jan. 26 and Feb. 5 before starting to recover.

Pension Accounting Increasingly Hurts

The market rally that began in March 2003 will pump up returns for corporate pension funds, but look for a record increase in pension losses charged against earnings in 2004. I know that doesn't make any sense, but that's the way the accounting rules for pensions work, thanks to an accounting rule called "smoothing."

Smoothing is intended to remove volatility from pension fund accounting so that big year-to-year swings in the gains or losses that companies make on their invested pension funds don't produce equally wild swings in a company's reported earnings. To dampen that volatility, the accounting rules let companies spread out pension fund gains and losses over several years.

The effect recently, however, has been to understate the losses (and the hit to earnings) these funds took in 2001 and 2002 when the stock market tanked. Those losses will actually take a bigger bite out of 2004 earnings than they did in 2003, according to Bear Stearns.

According to a Jan. 29 report by Bear Stearns, the 100 companies in the

S&P 500

with the biggest pension and postretirement benefit plans showed pension income of $3.3 billion in 2002, a terrible year for the stock market. In 2003, that swung to a $12 billion pension cost, and it will rise in 2004 to a peak of $16.6 billion before falling back to $12.3 billion in 2005.

But the effect of pension costs on earnings can go the other way at individual companies.

General Motors


, for example, contributed $18.5 billion to its very underfunded pension plan in 2003. Add that funding to the 18% GM projects it made on its pension fund investment in 2003, and the plan, once dangerously underfunded, is in much better shape.

Much of that money was borrowed, though, so GM has added a significant liability to its balance sheet.

But net/net, the effect on GM's earnings in 2004 should be significantly positive: Added interest costs come to just $550 million, and the reduction in pretax pension expenses adds up to $1.1 billion, according to the company's projections. Still, don't forget that GM comes out so well on the return from this massive borrowing because the company figures its pension plan will earn 9% on its investments next year. Borrowing at current interest rates and projecting a 9% return on its pension funds produces a gain for 2004 of about 70 cents a share, according to calculations from RBC Capital Markets.

Granted, it's just an accounting gain. But the gain will still show up in reported earnings. And generating earnings this way is much easier than producing earnings from selling cars in today's tough global automotive market.

To justify that 9% projected return, General Motors is moving some of its pension money to riskier asset classes. And if that doesn't work out? Well, thanks to smoothing, that's a problem for another year.

This Is Greater Clarity?

Many recently filed financial reports prove that obfuscation still rules. There's no need to pick on an obscure, small-cap stock, either. Here's one of my recent favorites from a big guy:

First Data



On Feb. 3, First Data reported earnings of 55 cents a share for the fourth quarter of 2003. After looking at the numbers, Wall Street analysts concluded that the company had actually made 54 cents for the quarter, matching the Wall Street consensus.

How did they arrive at that number? The company reported a $32 million after-tax gain from selling an investment portfolio. That's 4 cents a share that should probably be treated as a one-time gain. In its earnings release, the company said, "The gain was partially offset by reinvestments in the business including low-margin, start-up international businesses, the expansion of our Merchant and TeleCheck sales forces and Concord integration costs."

I'm sorry, but I don't see those as one-time expenses that "offset" a one-time gain. On the basis of the company's news release -- which is all investors have because the company's quarterly report isn't yet available from the

Securities and Exchange Commission

-- it looks like the gain should be deducted from reported earnings and the costs included.

But hey, maybe this will all get cleared up when the CEO has to put his name to the official financials. In the meantime, however, I don't think investors really know what the company earned in the fourth quarter of 2003. The stock is down 7.2% since Jan. 5.

So why all the fuss on my part over a few pennies here and a few pennies there? Two reasons:

  • The pennies can add up pretty fast. I'm looking at 70 cents a share at GM, for example, that, as an investor, I'm personally not willing to pay for if I buy GM shares.
  • We're looking at a year of declining earnings growth. The huge surge in earnings in the fourth quarter of 2003 is likely to represent the peak growth rate for earnings in this economic cycle, according to First Call. First Call's growth estimates for the rest of the year start off at 15% for the first quarter of 2004 and then march south to 12% for the second quarter and 11% for the third quarter before rebounding slightly to 13% in the fourth quarter.

With stock prices where they are and the general earnings growth rate likely to slow, every penny is likely to count in 2004.

At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Pepsico and St. Joe. He does not own short positions in any stock mentioned in this column. Email Jubak at