S&P alters its core earning methodology

Standard & Poor’s has reacted to criticism of its corporate rating methodology by changing its system for evaluating corporate earnings in the future. The New York-based rating agency will focus on core earnings – roughly defined as after-tax earnings generated from a company’s principal business or businesses – as the basis for its corporate equity analysis. The agency said the methodology was introduced to create greater transparency in corporate ratings.

Standard & Poor’s said its new classification of core earnings is based on the Generally Accepted Accounting Principles (GAAP) definition of ‘as reported earnings’ with some adjustments. The agency will include employee stock options, restructuring charges from ongoing operations, write-downs of depreciable or amortisable operating assets, pension costs and purchased research and development.

Excluded from this definition are impairment of goodwill, gains and losses from assets sales, pension gains, unrealised gains or losses from hedging activities, merger and acquisition related fees and litigation settlements

“A number of recent high-profile bankruptcies have renewed investors’ concerns about the reliability of corporate reporting,” said David Blitzer, Standard & Poor’s chief investment officer. “Once there are more generally accepted definitions, it will be much easier for analysts and investors to evaluate varying investment decisions.”

Leo O’Neill, S&P president, said the new analysis was widely supported in the analyst community. But one analyst questioned how popular the new methodology would prove with managers at US corporations. Sales/leasebacks, for example, have often been a way for airlines to boost earnings in depressed cycles and therefore manage the volatility of the industry. He was also concerned how analysts will view profitable hedging strategies that, if not implemented to boost revenues, may improve earnings all the same.