may have successfully allayed earnings concerns this week, but many market watchers are expecting a barrage of bad first-quarter earnings news.
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Author of Net Value
First Call/Thomson Financial
State Street Global Advisors'
CIBC World Markets'
Employment Policy Foundation's
G. Bennett Stewart III, a senior partner with management consultancy
, says investors should look beyond the short-term news to how well companies are investing their capital to ensure future growth. It's a principle his firm calls economic value added, or EVA. And in many cases, EVA can mean a hit on short-term earnings. Stewart explains:
As we begin hearing the expected barrage of negative earnings for the first quarter, investors are likely to be blindsided by all of the bad news. How should investors view these numbers?
Earnings are a really flawed measure. What appears on a balance sheet as a cost may actually be an investment that could drive up the value of a company over the next couple of years. Conversely, a company may be using pro forma or questionable accounting to achieve those earnings.
Amazon just announced an improvement in their earnings and their stock price increased 34%. I think that's actually more of a warning sign because it shows that Amazon is simply boosting its earnings in the near term, distracting investors away from the larger question, whether it has a sustainable business model.
So, no, investors shouldn't get too rattled by the upcoming earnings season or earnings shortfalls. Earnings per share is a measure of quantity.
We believe it's better to go behind the numbers to look at the quality of those earnings -- how a company achieved them and what it is doing to sustain them. Ask such questions as what is the risk and sustainability of those earnings? Is the company investing in such intangibles as the quality of their people, their knowledge capital, their technology, their brand, their market share, their reputation, their infrastructure, their research and development? Investors should remember quality of management.
A company stepping up its research could be the best thing in the world, but in the near term, it will appear on the balance sheet as a reduction in earnings and earnings per share.
Well, we know that capital and technology spending are way down, and layoffs are being announced every day. Are there
companies making additional investments in their people and in R&D right now?
It's unfortunately true that when business profits decline, managers are tempted to stabilize their reported earnings by cutting back on these investments in intangible spending. It's actually the biggest mistake they could make.
However, our database of companies making use of this long-term investment approach ... does show that there are a number of companies whose investments may not be reflected in current earnings -- including
How can an individual investor determine whether a company is making the kinds of long-term, forward-looking investments you're so keen on -- even if its earnings look weak?
It's hard to do. It requires really poring through 10-K's and annual reports.
One easier way is to see if a company is applying one of the business models that's working in today's economy. One model is Old Economy companies making use of New Economy Internets or intranets.
, the furniture maker, is one company that is making such a transition. Like
, Herman Miller offers a seamless Web integration from order entry straight through to their suppliers. This lets them dramatically minimize their inventory and inventory risk.
It's becoming more apparent that another business model that works today is for a New Economy company like Amazon to form partnerships with companies with a physical presence like
Toys R Us
The start-up airline
in New York is adopting a model like
by taking a lot of their orders over the Internet.
Are any money managers or investment banking houses making use of this enterprise value added accounting principle of yours?
, the head of equity research at
CS First Boston
, was one of the first people to embrace this approach in 1996. First Boston now uses EVA as a supplement to normal securities research to gain insight into the underlying quality of a firm's earnings.
Salomon Smith Barney
have also incorporated this approach.
Abby Joseph Cohen
has even said that all research at Goldman Sachs is EVA-based.