Most of the market tends to focus on profits on a pro-forma basis. We have never been big fans of this. These are the earnings numbers companies like to publish that steer attention away from the ?bad stuff?. My former colleague James Montier used to be highly scathing, describing them as “undefined, unregulated and untrue”. But because of their ready availability most in the market tend to quote pro-forma earnings numbers from the likes of Bloomberg and I/B/E/S and many base their equity valuations on this dodgy earnings metric. Yet even on this artificially inflated measure, trailing EPS grew only a paltry 5½% yoy in 2013, and 3% on a non-financial basis.
Andrew states that ?when looking at profit growth, a better profit series comes from MSCI. This definition of earnings is not as harsh as the S&P earnings definition incorporated into the likes of Robert Shiller?s cyclically adjusted PE (CAPE), but neither is it as overly generous as the pro-forma numbers supplied by I/B/E/S. To give you an example of the difference, during the 2009 profit slump S&P core earnings fell peak-to-trough by 92%, MSCI defined earnings fell by 55%, and I/B/E/S pro-forma earnings fell by 36%.
As we show above, not only are MSCI reported profits no longer growing, but the gap in thegrowth rate between these numbers and the pro-forma numbers is widening, with the proforma number considerably more ?optimistic?. ?This is a phenomenon that often precedes a more significant profit slump. It is also an indication that the quality of earnings is deteriorating."