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Author: jmls Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 766  
Subject: Dec. 18 Take: 18% EPS for GE is likely fudged... Date: 12/19/2001 1:55 AM
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Dear y'all,

I wish to comment on your "Motley Fool Take" for Dec. 18/01, in particular on the GE comments:

http://www.fool.com/news/take/2001/take011218.htm?ref=foolwatch

I cannot comment on Mr. Immelt's forecasts, other than to say they look awfully optimistic, but I wouldn't bet against GE. However, there is some fudging in the net income number.

In GE's press release,

http://www.ge.com/cgi-bin/cnn-storydisplay.cgi?story=/www/bw/webbox/bw.121701/213512671.htm

there are included in the 2002 estimate "a positive $.04-$.06 per share for the net effect of two non-cash items: a change in accounting for goodwill and a lower estimate of long-term returns on pension assets."

Without actually seeing the annual report I can only guess on exact specifics; but here's an attempt to break these down.

First, starting in 2002 companies no longer have to amortize goodwill. I'm not saying that this is wrong, in fact in a lot of ways this is closer to "reality" than the current system; but I wouldn't really count the gain as "earnings growth". GE is an acquisitive company, so this effect is pretty big. I haven't tabulated GE's many acquistions in 2001, but as of 2000 GE (including GE Capital, whose results are often broken out separately) had $23.5 billion in goodwill, and had an amortization charge of $1.06 billion. I think that the amortization charge would likely be higher in 2001 (more purchases!), but assuming it were the same, my calculations say that this is roughly a $0.106/share gain which is definitely "one-time" in nature.

Concerning the second component, the pension accounting. GE has a substantially overfunded pension plan. It became overfunded because for many years, GE has assumed a pension plan return of 9.5%, yet actually delivered high-teen returns. This overfunding can be realized as pension plan income, $1.27 billion worth of it in 2000. If you believe someone like Warren Buffett, stock returns will be more like 6-7% returns going forwards, and in fact GE's return on pension plan assets in 2000 was 2.6% (and including $2 billion in payouts, pension plan assets decreased in 2000). At some point going forwards, the overfunding will be run down, but "at some point" can easily be several years away; this gives Mr. Immelt a seriously large "fudge factor" for his net income. I think that Mr. Immelt is doing is reducing expected return on assets slightly to delay the "some point", and to take a few pennies off of the $0.106/share gain from net income arrived at above; after all, 18% EPS gain is plenty good for net income, let's save some gains for 2003!

There are many nuances to the 18% net income figure Mr. Immelt is putting out, not all of them directly relate to operations. GE is a great company, but they are famous for fudging income numbers. If I may humbly suggest this to the Fool writers, this sort of thing may be good for a future "quality of earnings"-type column at some point.

Best,

Lleweilun Smith
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