By applying core earnings adjustments, corporate reports will be
simplified and noncore transactions discarded for the purpose of
analysis. Once this idea is clarified and applied universally, investors
will be better able to use fundamental analysis to identify growth po-
tential with a clear field in view. The development of core earnings
may create a third form of accounting convention. We currently have
statutory-basis reporting (the form allowed under the tax rules) and
GAAP reporting (the loosely organized but broadly applied series of
conventions and standards aimed at improving overall accuracy and
consistency), which also includes possible adjustments under EBIT-
DA and the use of pro forma methods to set income valuation. The
third form of accounting may be called CEA, or Core Earnings Ac-
counting. As S&P continues to revise its proposed standards, and as
the company uses its core earnings adjustments to rate those corpo-
rations it tracks, it is likely that other organizations (such as Value-
Line, for example) are likely to follow suit. A trend has already begun
in which some corporations are making core earnings adjustments
voluntarily, recognizing the validity of reflecting core-earnings-based
reports to shareholders, even when accounting rules do not require
such adjustments.
Fundamental versus Technical Approaches
The question of how to apply core earnings adjustments has to also
take into account likely effects of such changes on market price of
stock. Even if that effect is only short term, it may also radically
change the way that we view stocks and their growth potential.
For example, if a corporation reports net earnings year after
year, we may develop a sense of confidence in that stock, at least to
the extent that earnings are a primary fundamental indicator that is
27
CHAPTER 1•CORE EARNINGS CALCULATIONS
followed each year. Of course, earnings serve as one of the primary
indicators, and the Wall Street obsession on earnings is well known.
The predictions made by analysts about quarterly earnings per share
are followed carefully by “the street” as a most important meas-
urement of corporate performance. In fact, the analyst’s prediction
(and how close actual EPS comes through) often is viewed as more
important than longer term growth prospects—at least to the ex-
tent that the accuracy of those predictions is factored into stock
prices.
At the point that the analyst’s prediction becomes a primary in-
dicator of “good” or “bad” results, the fundamental significance of
earnings has already been lost. This crossover from fundamental to
technical is dangerous. Even the most serious fundamental analyst
can easily be distracted by short-term reaction to earnings predictions
and may easily lose sight of more important trends.
Without making core earnings adjustments, the apparently
strong EPS of a company could be far weaker than it first appears.
In many instances, core earnings adjustments drastically reduce EPS
and may even change a reported profit to a net loss. Of course, core
earnings are the isolated earnings from operations, so one argument
could be made that the corporation in question did, in fact, earn the
reported profits. However, with the long term in mind, it is equally
valid to recognize that nonoperational profits are not going to recur
year after year and that the exclusion of items such as employee
stock options makes reported profits inaccurate. So, core earnings
adjustments are not merely theoretical for the fundamental investor.
These adjustments can serve as the basis for realistic analysis and not
merely as an alternative way to look at the numbers.
Is there a conflict between fundamental and technical? Of course.
If you decide to watch price trends without also identifying what is
going on in the fundamentals, then this limits your information. If
a corporation is not making core earnings adjustments voluntarily,
28
STOCK PROFITS:GETTING TO THE CORE

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