More 'phony numbers' in reports as stocks rise

NEW YORK -- Those record profits companies are reporting may not be all they're cracked up to be.

As the stock market climbs higher, professional investors are warning companies are presenting misleading versions of their results that ignore a variety of normal costs of running a business to make it seem they're doing better than they really are.

What's worse, the financial analysts who are supposed to fight corporate spin often are playing along. Instead of challenging the companies, they largely are passing along the rosy numbers in reports recommending stocks to investors.

An analysis of results from 500 major companies by The Associated Press, based on data provided by S&P Capital IQ, a research firm, found the gap between the "adjusted" profits analysts cite and bottom-line earnings figures that companies are legally obliged to report, or net income, has widened over the past five years.

At one of every five companies, these "adjusted" profits were higher than net income by 50 percent or more. Many more companies are in that category than there were five years ago. And some companies that seem profitable on an adjusted basis actually are losing money.

It wasn't supposed to be this way. After the dot-com crash of 2000, companies and analysts vowed to clean up their act and avoid highlighting alternative versions of earnings in a way that could mislead investors.

Offering an alternative view of profits that leaves out various costs is not new. It's legal, and sometimes helpful as a tool for investors to gain insight into how a business is doing.

But with stocks breaking record after record and the bull market entering its seventh year, there's more money riding on the assumption the earnings figures being touted by companies and analysts are based on sound calculations.

In its study, AP compared bottom-line profit figures that follow rules called generally accepted accounting principles, or GAAP, to the adjusted profit figures calculated by financial analysts and collected by S&P Capital IQ. AP looked at companies in the Standard & Poor's 500 index.

Most of the time, the adjustments made companies look better by leaving out things such as costs related to laying off workers, a decline in the value of patents or other "intangible" assets, the value of company stock distributed to employees, or losses from a failed venture. Critics argue these are regular costs and shouldn't be excluded.

Key findings

• Seventy-two percent of the companies reviewed by AP had adjusted profits that were higher than net income in the first quarter of this year. That's about the same as in the comparable period five years earlier, but the gap between the adjusted and net income figures has widened considerably: adjusted earnings were typically 16 percent higher than net income in the most recent period versus 9 percent five years ago. For a smaller group of the companies reviewed, 21 percent of the total, adjusted profits soared 50 percent or more over net income. This was true of just 13 percent of the group in the same period five years ago.
• Quarter after quarter, the differences between the adjusted and bottom-line figures are adding up. From 2010 through 2014, adjusted profits for the S&P 500 came in $583 billion higher than net income. Fifteen companies with adjusted profits actually had bottom-line losses over the five years.
• Stocks are getting more expensive, meaning there could be a greater risk of stocks falling if the earnings figures being used to justify buying them are questionable.

Three years ago, investors paid $13.50 for every dollar of adjusted profits for companies in the S&P 500 index, according to S&P Capital IQ. Now, they're paying nearly $18.