Despite Financial Engineering and Clever Reporting Schemes, S and P 500 Earnings per Share Stuck for 3+ Years, but Stocks Soar, by Wolf Richter

Wall Street has been putting lipstick on a pig—earnings have gone nowhere for three years, which means that a rising stock market has elevated price-earnings ratios into the stratosphere. It’s dangerous up there. From Wolf Richter at wolfstreet.com:

$1.7 trillion blown on making EPS look less bad.

The S&P 500 index, closing today at 2,373, hovers near its all-time high. Total market capitalization of the 500 companies in the index exceeds $20 trillion, or 106% of US GDP. In the three-plus years since the end of January 2014, the index has soared 33%.

And yet, over these three-plus years, even with financial engineering driven to the utmost state of perfection, including $1.7 trillion in share buybacks and despite “ex-bad-items” accounting schemes that are giving even the SEC goosebumps – despite all these efforts, the crucial and beautifully doctored “adjusted” earnings-per-share, perhaps the single most manipulated metric out there, has gone nowhere.

“Adjusted” earnings per share are back where they’d been at the end of January 2014. It’s a sad sign when not even financial engineering can conjure up the appearance of earnings growth.

Companies report earnings in two ways:

1. All companies report as required under GAAP (our slightly inconvenient Generally Accepted Accounting Principles). These earnings are often a loss or way too small and shrinking, instead of growing, and hence not very palatable.

2. So most companies also report pro-forma, ex-bad-items, “adjusted” earnings, based on the companies’ own notions of what matters. Analysts and the media hype that metric. This is just a method of reporting the same results in a more glamorous manner.

Then there’s financial engineering. Companies borrowed heavily over the past few years and used those funds to purchase their own shares. This hollowed out equity and left companies with piles of debt. Over the past three years, companies blew $1.7 trillion on share buybacks. This money was not invested in productive activities that would have expanded the company and the economy, and generated cash flow to service this debt. All it did was reduce the number of shares outstanding. This has the effect of increasing earnings per share (EPS) though the company didn’t actually make more money.

Add this system of share buybacks to the system of “adjusting” earnings per share via reporting schemes, and the result should be a miracle of soaring “adjusted” EPS. But no.

To continue reading: Despite Financial Engineering & Clever Reporting Schemes, S&P 500 Earnings per Share Stuck for 3+ Years, but Stocks Soar

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