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Shareholders’ Equity Analysis
- Are the stockholders really
owners?
- Do you know where your
equity dollars are?
- How comprehensive income
can affect stock values
- Watch out for your Dividends
- Stock splits, dividends
and reverse splits
- Spin-offs, tracking stocks
and determining new cost
basis
- Stock rights give board of
directors more power then
they are entitled to
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How comprehensive income can affect stock values
Comprehensive income items are non-owner transactions
charged directly to shareholders’ equity. Academics can make arguments
either way as to the appropriateness of charging shareholders’ equity versus
the income statement. The accounting profession, nonetheless, usurped the
shareholders’ rights by allowing the following types of non-owner
transactions to be charged directly to equity:
·
Foreign currency translation adjustments
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Minimum pension liability adjustments
·
Unrealized gains or losses on marketable securities
·
Unrealized gains or losses on derivative instruments
This is more then a “geography” discussion as to
where on the financial statements certain items should be classified. Many
times, comprehensive income adjustments become hidden expenses; for some
companies, the amounts are enormous.
Here, for example, is another poignant illustration
supplementing the text: Boeing, for the year ending December 31, 2002,
reported net income before accounting changes of $2.3 billion, down from
$2.8 billion in 2001. (Not bad for a company whose customers and main
markets were devastated after 9/11.) In 2002 they also had a $1.8 billion
asset impairment charge, primarily from their space and communication
segment, relating to a new accounting regulation on handling goodwill and
acquired intangibles. The write-down basically resulted from projected cash
flows from their acquisitions, which did not cover the goodwill and other
intangible assets that were recorded on their balance sheet. In effect, the
future business prospects of their acquisitions did not justify the price
paid for them. This resulted in Boeing reporting $492 million net earnings
for the year, with the Company proclaiming that they had a “solid
performance in dynamic markets from Boeing’s balanced portfolio of aerospace
businesses.”
Then, when reviewing the equity section of the
financial statements, one finds that equity was reduced by a staggering $3.1
billion for the year, or a 29% reduction in equity from the prior year. Most
of it originated from a $3.6 billion (net) pension adjustment, or $5.7
billion before taxes. Keep in mind that the focus of this book is the
stockholder. While the company’s operations did have a solid performance,
the equity owners took a bath; first, on the $1.8 billion P&L asset
write-down, then on the $3.6 billion equity pension adjustment. This is why
I call comprehensive income adjustments hidden expenses. Dividends aside,
the stockholders started the year with $10.8 billion in equity and ended the
year with $7.7 billion in equity. It took approximately 86 years to build up
that equity, only to lose 29% of it in one year! That said, Boeing is still
a world class organization and is usually a good buy on price dips.
The question now is: what is the bottom line?
I’ve always had the conviction that all transactions
should “run through” the current year’s P&L. Charging equity directly or
restating past results tends to disguise the reality of a situation.
Investors
must focus on net income, as well as comprehensive income, when measuring
stock values. If book value is reduced, it ultimately will reduce the value
of one’s stock.
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