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Four Ways Companies mislead Investors in earnings reporting using Intel as an example

InvestorEducation / Investing Jan 23, 2007 - 10:15 AM GMT

By: Money_and_Markets

InvestorEducation

Intel recently reported its fourth-quarter results. The headlines celebrated the fact that the semiconductor company delivered $0.26 a share in profits, beating the Wall Street consensus estimate by a penny. Everyone seems impressed … except me. In fact, all I see is a company whose business is sinking fast, and a stock that's going to get hammered.

So today I want to use Intel as an example of how companies use different tactics to convince investors that everything is better than it really is. Think about these the next time you're about to buy a stock …


Financial Fun and Games #1: Income Statement Hanky Panky
Intel's $0.26 in per-share profits were created with financial smoke and mirrors. The company actually made $0.256 a share, but thanks to the magic of rounding up, Intel was able to squeeze out an extra half a penny in profits.

That might not sound like much at first. But remember, we're talking about per-share profits. Half a penny times about six billion shares isn't exactly chump change! Plus, that rounding up was the difference between meeting Wall Street's expectations and beating them.

Intel also used $4.6 billion to repurchase 226 million shares of stock in the last year, which resulted in a reduction of the number of outstanding shares from 6.1 billion to 5.8 billion. If those 300 million shares hadn't been bought back, earnings would have been reduced by another $0.03 a share.

And let me tell you, Intel is a master of income statement manipulation. For example, the company sold off its application processor business to Marvell Technology last quarter and classified that gain as operating profits. That's extremely misleading since the sale is a one-time event. The gain increased Intel's fourth-quarter earnings by approximately $0.025 a share.

End result: Take away that rounding up, the share buybacks, and the one-time gain and Intel actually missed analysts' expectations by a nickel.

As an investor you absolutely need to look below the surface when it comes to these numbers … you can't assume that the announced earnings figure is a true representation of how much the company is making from its main businesses.

Intel - As an investor you absolutely need to look below the surface when it comes to these numbers

Financial Fun and Games #2: Balance Sheet Shenanigans
It isn't just Intel's income statement that raises my eyebrow. Take a look at the company's balance sheet …

Intel is sitting on $3.4 billion of unsold inventory, which is about the same amount it had in July. Here's the important difference — the company is now heading into what is traditionally its slowest period. Moreover, unsold inventory has ballooned by 38% from the fourth quarter a year ago.

To really put this idiotic buildup into the proper perspective, remember, sales fell 5% in the last 12 months. Listen, anytime you see a company with falling revenues and skyrocketing inventory, you are looking at a company in big trouble.

And there's more …

Intel's cash hoard is shrinking. Intel had $11.3 billion of cash and short-term investments at the beginning of the year but only has $8.8 billion now.

Can you say “burning through cash?” Be on the lookout for this kind of stuff before you invest in any company!

Financial Fun and Games #3: Talk About Tomorrow Instead of Yesterday
I don't know about you, but when I buy a stock, I want a company with rising sales and profits. Intel knows this is what investors are looking for, so it avoids making year-over-year comparisons.

Reason: If you do compare the company's fourth-quarter results to the same period a year earlier, you'll see just how bad they look …

In the fourth quarter of 2005, the company made $2.45 billion in profits. In the fourth quarter of 2006, it only made $1.5 billion. That's a 39% drop!

And the sales side isn't much better. Revenues for the fourth quarter of 2006 were $9.7 billion, down 5% from $10.2 billion a year ago.

These results, especially the shrinking sales, tell you exactly how tough the processor chip business is, and how poorly Intel is really doing.

Financial Fun and Games #4: Promise Investors That You'll Get Lean and Mean
Intel would have investors think that its restructuring plan, which includes spending and manufacturing cuts, will save $2 billion in costs and send its profits to the moon.

Now, $2 billion is indeed a lot of money, but once you look at the footnotes, you'll see how misleading that claim is — I'm talking about the phrase “exclusive of restructuring costs.”

See, Intel massively reduced its workforce. The company laid off about 8% of its workers in a year. That's not a cheap move — severance pay, training allowances, and early retirement costs will eat up most, if not all, of that $2 billion in supposed savings.

And here's my larger point: The whole concept of excluding this or that permits Intel to sweep its mistakes under the rug. Plus, it makes the company's results look way better than they really are. Heck, if I were able to exclude 50 pounds, you could call me skinny.

What This Means for Intel and Investors
All the financial fun and games are simply Intel's way of sidestepping the real problem — it's operating in a mature industry whose best days are in the past. Prices for technology items have come down, and the profit margins just aren't there anymore.

Think about it … TVs, calculators, microwave ovens, cell phones, long distance land-lines, and copiers are all industries that enjoyed gangbuster profits at one time, but eventually their glory days faded. Unless you're a hard-core Internet gaming addict, there's no reason to spend more than $1,000 on a PC anymore. Today, you can get a wonderful setup for $500 or $600.

And how much of that $500 do you think a company like Intel can hog for itself? The two-fold answer is “not much” and “a lot less than it used to get.”

If you're a long-term reader of my column, you already know that I've been singing the same song since Intel was a $60, $50, $40, and $30 stock. But let me say it one more time — I expect Intel to become a sub-$10 stock.

Fund Ticker Investment in Intel
Integrity Value IVUAX 6.8%
Van Kampen Exchange ACEHX 6.6%
Kelmoore Strategy KSOIX 5.9%
White Oak Select Growth WOGSX 5.8%
Pioneer Growth Leaders LRPSX 5.3%
IXIS Harris Focused Value NRSCX 5.1%
Sycuan U.S. Value SYCUX 5.0%
American Heritage Growth AHEGX 5.0%
Source: Morningstar

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One other warning: Some of you may be big Intel shareholders and not even know it. I put together a list of mutual funds that have at least 5% of their portfolio invested in Intel. In my opinion, any fund with that much of its portfolio in Intel is destined to headline a future worst performers list. So don't listen to the Wall Street cheerleaders, Intel's management, or the underpaid reporters with no money to invest.

And be on the lookout for these same tactics from other companies, too. Plenty of firms are using smoke and mirrors to hide the painful truth from investors.

Best wishes,

Tony Sagami

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.MoneyandMarkets.com


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