Earnings Quality or the Lack Thereof

KPMG recently announced the results of a study of 1,064 public companies (minimum revenues $500 million, minimum capitalization $500 million, and minimum assets of $300 million) looking at the magnitude of goodwill impairment for the period from January 2006 until December 31, 2008. Most of the surveyed companies did their SFAS 142 required impairment testing in the fourth calendar quarter.

The surveyed companies had $87 billion in impairments in 2006, $143 billion in 2007, and $340 billion in 2008. Banks were the hardest hit, accounting for 23% of the total goodwill impairment reported by the surveyed group of companies. Within industries, 30%+ of the companies surveyed in semiconductor manufacturing, technology, and media sectors reported impairments during the survey period.

The median banking industry impairment was $411 million in 2008 versus $49 million in 2007. The materials industry's reported impairment was $394 million in 2008 versus $30 million in 2007.

So, if we are looking at the quality of earnings and balance sheet health coming into second quarter reporting season, we would suspect that earning quality will have declined. The asset side of the balance sheets of financial companies will still be of dubious quality at best.