Types And Sources
In the U.S., there are two main types of income: as reported and operating. As reported income, sometimes called Generally Accepted Accounting Principal (GAAP), is income from continuing operations and it excludes discontinued and extraordinary income. Both of these terms are defined by the Financial Accounting Standards Board (FASB) under GAAP. As reported earnings represent the longest-monitored earnings series available today.
Operating income, by contrast, excludes unusual items from that value, and companies began reporting it in 1988. The intent for operating earnings is to show how much companies make from their operations (making widgets), excluding corporate expenses and unusual items. Operating income is not defined under GAAP by the FASB; however, companies are required to reconcile how they get from their operating income figures to their as reported income figures. This permits individual companies to interpret what is (and what is not) unusual. The result is a varied interpretation of items and charges, in which the same specific type of item may be included in operating earnings for one company and omitted from operating earnings for another company. Additionally, during difficult times, the term ‘unusual’ appears to be used more liberally.
S&P uses methodology to ensure items included (or excluded) from operating earnings are consistent across sector lines, in order to permit issue comparison. In general, as reported earnings are less than operating earnings, since they exclude corporate expense and write-offs. However, on occasion, the situation occurs where there are unusual income items, which reverses the normal trend.
Things get a bit more complicated for index-level estimates because there are two methodologies used for calculating the S&P 500 index level estimate: bottom-up and top-down. Bottom-up estimates come from the covering equity analyst for their specific issue. We then build up the index level estimate by combining all 500 issue level estimates, after each issue’s estimate is adjusted for its index weight. These are the more commonly used estimates on the street. On an issue level, bottom-up estimates are typically the ones used to determine if a company met expectations or not.
Top-down index-level estimates are usually supplied by economists and strategists on an index and (sometimes) sector level. They use a broad array of indicators and matrices based on economic and market history to project the index level earnings estimate. The economists or strategists never come down to the issue level and say how much a company will make, but instead make their estimates from the top down. They may adjust the index, sector, or group estimate based on overall economic beliefs, such as expected employment, tax rates, government costs, and expenditures. Economists will typically create estimates that project over many years, while strategists will generate them for just a few years (similar to equity analysts).
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