(A commentary on Bloomberg by Jonathan Weil)
You can’t have a price-earnings ratio without earnings. And by one important financial benchmark, the Standard & Poor’s 500 Index doesn’t have any. The earnings gauge I’m referring to is called comprehensive income. While there’s a good chance you have never heard of this before, it’s a far more inclusive measure of profitability than the better-known subset, net income. The term also has a well- defined, standardized meaning under the accounting rules.
Comprehensive income is the change in a company’s shareholder equity during a given period, excluding the effects of new capital injections and dividend payments. By this measure, S&P 500 companies had combined losses in the past four quarters of about $200 billion, according to data compiled by Bloomberg and my own review of the companies’ financial reports. In other words, there is no P/E ratio, because there is no E.
By contrast, S&P 500 companies had about $295 billion of combined net income during the same period, which translates into a P/E ratio of about 25 times earnings for the index. That’s not cheap, by historical standards. And it’s a lot to pay for Botox earnings that are unnaturally stiff and cosmetically enhanced.
Investors might not pay much attention to comprehensive income. They should. Net income, regardless of its bottom-line reputation, has become so polluted that it’s no longer a reliable measure of profit or loss. A more accurate name would be comprehensive income excluding stuff that management wants you to overlook. The problem is about to get worse, too.
Starting this quarter, in a bow to pressure from the banking industry and its water carriers in Congress, the Financial Accounting Standards Board has proposed letting companies report net-income figures that ignore severe, long- term price declines in the stocks and debt securities they own. The way the rules stand now, companies must record charges to net income whenever they decide that such losses aren’t temporary.
In most cases, under the FASB’s proposal, companies would be able to keep non-temporary losses out of net income. That’s on top of several other things net income already excludes, such as gains and losses from retiree-benefit plans, certain derivative contracts, and foreign-currency fluctuations. All these will continue to count in comprehensive income.
The gulf between net and comprehensive income usually isn’t as wide as it is now. Tally up the 2007 results for S&P 500 companies, and their combined comprehensive income was $784 billion, compared with $660 billion of net, according to Bloomberg data. That was back when corporate pension plans were comparatively flush, because of low interest rates and rising markets, and companies were more likely to show gains on their securities holdings than losses.
The past year’s sea of red ink, especially at financial institutions, has taken a toll on both profit measures. At some companies last year, the difference between the two was huge. General Electric Co. reported 2008 net income of $17.4 billion, and a $12.8 billion comprehensive loss. Citigroup Inc.’s $48.2 billion comprehensive loss was $20.5 billion wider than the bank’s net loss. Bank of America Corp. reported $4 billion of net income, and a $7.9 billion comprehensive loss.
Reason for Disparity
MetLife Inc. had a similar disparity, with $3.2 billion of net income and a $12.1 billion comprehensive loss. At Wells Fargo & Co., net income was $2.7 billion, compared with a $4.9 billion comprehensive loss. The differences in each instance arose from losses that had to be recognized on the companies’ balance sheets and equity statements, but not their income statements.
To be sure, if we excluded banks and other financial- services concerns, the combined comprehensive income for the rest of the S&P 500 index would have been slightly positive. Yet financial companies weren’t the only ones with vast differences between their net and comprehensive results.
International Business Machines Corp. reported 2008 net income of $12.3 billion, and a $6.1 billion comprehensive loss. AT&T Inc.’s net income was $12.9 billion, at the same time it had a $3.8 billion comprehensive loss. Boeing Co. had $2.7 billion of net income and a $6.3 billion comprehensive loss. All three companies have sizable defined-benefit pension plans.
Comprehensive income has many of the same problems as net. It depends on lots of subjective estimates — everything from when to recognize revenue, to the size of loan-loss reserves and depreciation expenses for hard assets. And just like net, it may get an artificial boost from a separate FASB proposal that would take effect in time for first-quarter results; this one would give companies more room to substitute their own judgments for market values when measuring their financial assets’ worth.
That said, comprehensive income is the closest thing there is under generally accepted accounting principles to an all- encompassing profit figure. The biggest challenge for investors often is finding it.
Although companies must disclose the number in the quarterly financial statements they file with regulators, they don’t show it on their income statements. Usually they list it on their statements of shareholder equity or bury it in the footnotes. Most companies don’t mention the figure at all in their quarterly earnings releases.
None of that will change, unless investors start demanding that companies disclose the information sooner, and more prominently. With another quarterly earnings season about to begin, the time to speak up is now.