With so much investor skepticism over pro forma earnings this year, Merrill Lynch ( MER) has decided to change the way it analyzes financial results. The move comes two months after Merrill and the New York State Attorney General Eliot Spitzer settled a 10-month long investigation into the firm's research practices. Merrill has come under heavy criticism for publicly touting certain Internet stocks while privately disparaging them. But it has also reaped scorn for failing to detect and report various accounting schemes at companies like Enron and WorldCom. From now on, the brokerage said its analysts would focus not only on how much a company earns, but also on the underlying quality of those earnings.
S&P ranks several thousand companies from A+ to D based on the stability in the growth of earnings and dividends over the last 10 years. Among industries, consumer staples ranked highest while health care was somewhat disappointing. Unsurprisingly, technology ranked last because of its low return on capital and asset replacement and low cash realization. During a conference call Thursday morning, Merrill said that in addition to providing pro forma earnings estimates, analysts would also offer estimates based on generally accepted accounting principles. If there are big differences between the two, analysts must explain that. In its analysis, Merrill found that 78% of S&P companies use some type of non-GAAP earnings. Last year, pro forma numbers were 53% higher than GAAP results.