Bracing for an earnings hit - Babson College



Bracing for an earnings hit | |

|A Merrill Lynch study shows what earnings would be if options were expensed: A lot |

|lower. |

|July 11, 2002: 1:22 PM EDT |

|By Justin Lahart, CNN/Money Staff Writer |

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|NEW YORK (CNN/Money) - A new Merrill Lynch study suggests that the earnings investors |

|base their valuations on could be wildly overstated. |

|At issue is the way companies account for employee stock options, a growing bone of |

|contention both on Wall Street and in Washington. The salaries companies pay employees |

|are of course accounted for as expenses and detract from earnings. But employee stock |

|options --another form of compensation -- don't. |

|Merrill analysts went through the financials of every company in the benchmark S&P 500. |

|If options were treated as an expense, total earnings for companies in the index would |

|have been 21 percent lower in 2001 than what was reported. Earnings in 2000 would be 8 |

|percent lower. Earnings this year would be 10 percent lower. |

|"To assume that option grants are not an expense is to assume that the real resources |

|that contributed to the creation of the value of the output were free," said Alan |

|Greenspan in a May speech. |

|Warren Buffett has translated that into English: "If options aren't a form of |

|compensation, what are they?" |

|Whether lawmakers decide that options grants should be treated as expenses is an open |

|question. Some, like Senators John McCain and Carl Levin, think it should happen but |

|lobbying from companies opposing the move has been intense. Small wonder: Change the way|

|options are accounted for and things start to look a whole lot different. |

|All of a sudden, stocks look a whole lot more expensive. The S&P trades at 18.3 times |

|this year's expected earnings the way they're currently calculated, but start calling |

|options expenses and its 2002 P/E is 20.4. Yipes. |

|Who's most vulnerable? |

|Nowhere would the hit be harder than in the technology arena, where companies regularly |

|use stock options to lure talent. According to the Merrill study, if options are treated|

|as expenses S&P 500 tech earnings would have been 39 percent lower in 2001 than reported|

|and would drop a whopping 71 percent in 2002. |

|The hardest hit on an absolute basis? Yahoo!, which would have lost $1.73 a share in |

|2001 against the 16 cent loss the company reported. Expense options this year and Yahoo!|

|is expected to lose $1.47 versus an expecation of a 10 cent per share profit. |

|But all the tech faves would get hit. Cisco earnings would come in 67 percent lower this|

|year if it expensed options, Merrill estimates. Intel's earnings would drop by 25 |

|percent, and Microsoft's by 22 percent. JDS Uniphase would swing from a loss of 11 cents|

|a share to a loss of 51 cents. Sun Microsystems would drop from a loss of 23 cents from |

|a loss of 8 cents. |

|According to Merrill, the options expense hit would be minimal at consumer staples |

|companies (outfits that produce essential things for living, like diapers, food and |

|beer), energy companies and utilities.  [pic] |

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