The More You Look, the Weaker Earnings Look

Last year's modest rise over a catastrophic 2001 may well be repeated this year

In an ordinary year, the surge in corporate profits in 2002 would be drawing huzzahs from economists and investors alike. Take away AOL Time Warner Inc.'s (AOL ) $44.6 billion loss, which was so huge that it skewed results for the entire sample, and full-year earnings for the 900 companies in BusinessWeek's Corporate Scoreboard zoomed 23%. That's the best result since 1994, when profits jumped 40% as the country climbed out of another slump.

If only it were so simple. In fact, last year's earnings picture was much weaker than it appeared. Include AOL's loss in the 2002 Scoreboard total and the profit increase for all industries drops from 23% to only 7%. And overall 2002 profits were still 50% below their peak in 2000. Big jumps often were achieved by easy comparisons with 2001, when overall profits fell an astounding 59% as companies wrote off billions in goodwill to reflect the stock market's tumble and changed accounting rules. Only easy financing buoyed spending on new cars and homes last year. And companies that did manage to boost profits rarely did so by revving up sales or raising prices, instead resorting to cost-cutting.

It looks as if 2003 will be another year of treading water. Already, 273 companies have trimmed their first-quarter earnings estimates, up from 212 at this point last year, according to Thomson First Call. While some CEOs are holding out hope for a late-year rebound, they may be disappointed. General Electric Co. (GE ), the company generating the most profits last year, managed to squeeze out a 7% increase, to $15.1 billion. But CEO Jeffrey R. Immelt says this year's earnings per share could come in at anywhere from a healthy 13% rise to an anemic 3% gain.

GE is actually in better shape than most. Few companies enjoy any pricing power, reflected in the weak 3% sales increase for the Scoreboard last year. A rebound in demand is unlikely in 2003, given the threats to the economy, from rising energy prices and health-care costs to heightened international tensions. Gross domestic product is expected to grow a modest 2.7% this year, according to a February survey by Blue Chip Economic Indicators. BusinessWeek economists expect profits in the broader economy, including private companies, to improve 10%--a far cry from the 15% to 25% jump usually expected coming out of a recession. Says PNC Financial Services Group Inc. Chief Economist Stuart G. Hoffman: "We haven't seen [a rise like that] in 2001 or 2002, and I don't see it in 2003."

Still, give credit where credit is due--42 of 57 industries turned in profit gains for the year. (There are many ways to calculate profits. BusinessWeek uses income from continuing operations before extraordinary items, as defined by generally accepted accounting principles, or GAAP.) Auto makers made the biggest U-turn, boosting sales 4%, thanks to 0% financing and other incentives. General Motors Corp. (GM ) rang up $1 billion in fourth-quarter profits alone--almost quadruple what it made in the fourth quarter of 2001. For the year, GM's profits rose 189%, to $1.7 billion--90% of it from sport-utility vehicles and pickup trucks. GM used aggressive price incentives to keep sales up, but it helped to have the lowest costs of any U.S. carmaker. "People criticize us for the incentive strategy, but it's working for us," says CEO G. Richard Wagoner Jr.

As rock-bottom interest rates helped boost home buying and refinancing, consumer banks rang up big fees and boosted overall profits 39%, to $52.6 billion. Bank of America's (BAC ) profits alone jumped 36%, to $9.2 billion. Yet with delinquencies rising on loans and with interest rates already at historic lows, banks can't expect a reprise of the refi boom. And the big investment houses have been stung by bad loans, regulatory fights, and a steep falloff in investment banking. No outfit reflects the split fortunes of finance better than Citigroup (C ): Earnings from consumer loans jumped 21%, but overall profits rose just 2%, to $13.4 billion. Citi took a $1.3 billion charge to cover fines and legal costs expected from federal and state investigations into its stock research.

In the beaten-down technology and telecommunications sectors, there was even less reason to cheer. Corporate buyers continue to hold off on big purchases, choosing instead to make do with what they've already got, and consumers won't open their wallets without deep discounts. A few behemoths enjoyed substantial growth--most notably Microsoft Corp. (MSFT ), which earned a cool $9.5 billion in calendar 2002, 57% more than 2001. Sales of its software typically track new-computer sales, which Microsoft expects will remain weak this year. The solution: steer corporate buyers into subscription deals that generate recurring revenues and bigger profits.

Devoid of Microsoft's monopoly power, the rest of Techville could boost profitability only by cost-cutting. No sector wielded the ax more mercilessly than telecom. Verizon Communications Corp. (VZ ) grew its sales by just 1% in 2002, but its $4.6 billion in profits were 677% higher than in 2001, when weak results were worsened by big severance costs and writedowns of bad investments.

One loss dwarfed them all. As investors soured on the marriage of AOL and Time Warner, the company had to take two monster write-offs to reflect the declining value of its assets. That resulted in a loss of $44.6 billion--or $99 billion, if you factor in cumulative accounting changes, which is how AOL reported it. As AOL sheds assets and looks to raise $4 billion in a public offering of its cable unit, CEO Richard D. Parsons has dubbed 2003 a "reset" year.

Of course, AOL isn't alone in having to pay for sins committed during the boom. The good news: Economists believe that, having taken their lumps, downtrodden companies will be well-positioned to benefit later this year. Yet war is only one way that rosy scenario could be canceled out. "The menu of risks and uncertainties is long," says Prudential Securities Chief Economist Richard D. Rippe. More like an all-you-can-eat buffet for the economy's pessimists.

By Andrew Park in Dallas, with bureau reports

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