If the market cares so much about clean, straightforward financials in the wake of Enron's collapse, why is Whirlpool's ( WHR) stock up 30% since September?

The appliance maker reported fourth-quarter earnings that claim to show dynamic "core" earnings growth. But, as Detox has pointed out before, Whirlpool's core pro forma numbers actually provide investors with very little idea of how its fundamental operations are performing. A steep late-afternoon drop in the stock Wednesday, long after investors had digested the earnings report, suggests Wall Street may be coming around to that view as well.

Value buyers watch out. The stock appears cheap, trading at about 11 times company-forecast 2002 earnings. But sales are barely growing, and if, as this column believes, true operating earnings are actually half the reported number, Whirlpool is trading at an indefensible 20 times earnings. The stock will inevitably head south.

The Usual Suspects

Whirlpool fired back late Wednesday, after receiving questions for this article, reaffirming earnings guidance and blaming the fall in its share price on market rumors "questioning the integrity of our 2001 earnings." CEO David Whitwam thundered, "These rumors are completely without merit. We stand behind the integrity of our financial reporting."

However, Whitwam may be fighting a tough battle in a market draped in skepticism. Following the accounting scandals of recent months, pro forma earnings have come to be seen as a real curse. Countless companies offer specially doctored income statements that say little about the ongoing strength of their business. This habit, which became prolific in the '90s bubble, has drawn the attention and ire of regulators and investors.

Whirlpool's fourth-quarter earnings illustrate the pitfalls of pro forma earnings. If we strip out the noise and the clutter in the quarter, earnings turn out to be more than 40% lower than the $1.58 in per-share profits Whirlpool actually reported. Investors, who judging by the stock's rise seemed until Wednesday not to have grasped what's going on, sent the stock down $7.04 or 9.7%, to close at $65.50.

By the Numbers

Below is a table showing a list of items that helped boost fourth-quarter profits, ranked in order of magnitude. Together, they add up to 68 cents a share, which is equivalent to 43% of the total.

The Pro Forma Rinse
Assorted items that boosted Whirlpool's fourth-quarter pro forma earnings
Amount (millions)** Amount (per share)*
Items excluded from cost of goods sold $18 0.18
Pension benefit 15 0.15
Brazilian tax credit 13 0.13
Decline in credit reserve 10 0.10
Items excluded from SG&A expense 6 0.06
Sequential decline in tax rate 4 0.06
Total $66 0.68
Pro forma earnings - 1.58
Special items as a percent of pro forma earnings -- 43%
Source: Detox
*Assumes 32% tax rate and a 69 million share count.
**Pretax amounts

The biggest item is $18 million of costs that Whirlpool has excluded from its costs of goods sold line in its income statement. How should this item (and a similar $6 million left out of operating, or selling, general, and administrative (SG&A), expenses) be treated? A company spokesman says these two items are "associated with restructuring" and therefore should be left out of recurring earnings calculations.

But why not include them in the $83 million restructuring charge taken in the period and also left out of pro forma earnings?

Because they are "costs for moving and relocating equipment and people," the spokesman says, adding that booking them outside of the main charge is "in accordance with accounting rules." He didn't elaborate when asked why they shouldn't, then, be booked as operating costs.

The pro forma earnings number was also given a big boost by a credit arising from Whirlpool's pension-fund assumptions and by tax credits it gets in Brazil. Neither of these reflect the operating strength of Whirlpool and should be ignored. In addition, Whirlpool has reduced the protection it keeps on its balance sheet against losses caused by nonpaying customers. If, in the fourth quarter, it had moved its credit reserve up to the level it was at a year ago, it would've added $10 million to costs.

In Whirlpool's defense, receivables have fallen from a year ago, so perhaps reserves for unpaid accounts should too. However, the weakness of the economy might suggest otherwise. The spokesman says movements in the credit reserve don't have any impact on the income statement.

Finally, Whirlpool's tax rate dropped to 32.2% from 34.4% in the third quarter, giving a 6-cent benefit to earnings. "The tax rate is what the tax rate is," the spokesman says.

So far, we've assumed that all is fine with the hefty $150 million restructuring charge Whirlpool took in 2002. We shouldn't. The regularity with which Whirlpool has used such charges is good grounds for considering them recurring costs. Skeptics wonder whether the company is burying operating expenses in them, something Whirlpool has denied. And the charges just keep coming. In 2002, the company expects to take another $150 million to $200 million of restructuring charges, clouding earnings for another year.

Bottom line? Whirlpool's true core earnings could be just half the expected $6 a share for this year. Thus, the stock should trade at no more than 10 times $3, or $30 -- more than 50% below current levels.
Know any companies that the market may be misvaluing? Detox would like to hear about them. Please send all feedback to peavis@thestreet.com.

In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.