Earnings estimates awry
Wall Street analysts are having a little difficulty with their marksmanship this year. When it comes to making valid earnings estimates, it's like trying to hit a bull's-eye on a fast-moving target.
What's throwing the analysts off is all the recent accounting and tax code changes. Fred Fraenkel, director of investment strategy for E. F. Hutton, agrees that it has been a tough year for earnings estimates, adding that lately he has been ''catching bricks'' because of his many changes in the estimates.
Another analyst says making the estimates this year has been an exercise in creative financing. In fact, David L. Babson & Co., investment advisers, recently told subscribers to its Staff Letter that it gave up on making corporate earnings comparisons last year ''because the increasing complexity of accounting methods made company-to-company comparisons almost meaningless.''
What is rippling the analysts' estimates has been such obstacles as:
* A forthcoming change by the Financial Accounting Standards Board of its rule governing foreign-exchange gains or losses. Under the old rule, called FAS- 8, realized or unrealized gains or losses had to be reported in the quarter in which they were taken. These gains or losses flowed directly to the income statement, affecting earnings per share. Under the proposed new rule, which will be known as FAS-50, the gains or losses won't be included in the earnings statement, but will be placed directly in stockholders' equity, a less-closely monitored balance sheet item. Since the change in accounting methods can be done retroactively, a lot of big companies whose earnings have been hurt by the strength of the dollar this year will likely restate their 1981 earnings.
A Merrill Lynch analyst, wishing to remain anonymous, says most of the analysts he knows ''are praying'' the accounting rule change goes away. But since this is not expected, analysts have begun by asking the company what effect currency adjustments will have. Then they assume that exchange rates will hold at present levels, or likely trend against the dollar. Finally, they are applying the new FAS-50 rule change to companies they follow.
Mark Tavel, director of research at the Value Line Investment Survey, says his firm has decided not to go back to restate corporate earnings based on the change in the FAS-8 rule. ''Stock prices react to earnings reported,'' he explains, adding, ''Sometimes investors will look beyond the report to look at underlying operating earnings. If some companies have been clobbered the first nine months because of the strong dollar, you can't change what their stocks have already done.''
For the fourth quarter, however, Mr. Tavel admits it's likely that some companies may get a favorable gain when the new accounting rule is passed. ''People do tend to respond to positive earnings even when they are not from operations,'' he says.
* The 1981 tax legislation has created a virtual gold mine for companies wishing to offset their earnings by purchasing other companies' investment tax credits. For example, International Business Machines Corporation has purchased several hundred million dollars' worth of tax credits for an undisclosed amount of money (only a portion of the value of the tax credits) from such companies as Ford Motor, CSX Systems, Pacific Southwest Airlines, and B. F. Goodrich. These companies needed the cash from IBM and not the tax credits, since they don't have the earnings to use the tax credits on.
The net effect of these purchases on the acquiring companies is unknown at this point. For example, Robert Christensen, an analyst who follows IBM for A. G. Becker Inc., says he doesn't know the effect of the tax credits on IBM and adds: ''I don't think I'm alone. We don't know the size of the deals and the depreciation rates.'' However, he continues, ''I don't think investors are buying IBM due to tax deals, but because they are investing in a leading company in an excellent business with growing revenues.'' This year, in part because of the recession, IBM will close out what Mr. Christensen calls a ''lousy year,'' with lower earnings - possibly $5.60 a share, compared with $6.10 last year. Another analyst notes that the investment tax credits will probably have only a minuscule effect on IBM's bottom line in the next few years.
* A lot of brokerage houses have been off on their economic forecasts. Curt Lemkau, vice-president and director of fundamental research at Merrill Lynch, notes that his company lowered more earnings forecasts than it raised last quarter, in large part because interest rates were higher than expected.
Mr. Fraenkel of E. F. Hutton agrees that the economy caused the analysts the biggest problems. ''Believe it or not,'' he says, ''the recession had a bigger impact than the tax cut.
Interest rates continued to fall last week, but Wall Street was not impressed. Stocks, after a strong start, fell off by the end of the week and the Dow Jones industrial average closed with a gain of 3.43 points, closing at 855. 88. Volume was relatively heavy.