Most investors are fully cognizant of these unfunded liabilities and
have taken down the value of the auto manufacturers as well as other
firms that have large underfunded pension plans. The bankruptcy of
the steel manufacturers and airlines over the last decade are related to
their inability to meet their pension obligations. By mid-2007, because
of rising stock prices and interest rates (which help reduce the magni-
tude of the pension obligation), overall the S&P 500 firms were fully
funded with respect to their pension obligations but still were about
$300 billion underfunded in health and other postretirement employee
benefits (OPEB).^18
Since virtually all pension plans started in the last 20 years have
been set up as DC plans and have sharply cut back or eliminated retiree
health benefits, the corporate pension problem will disappear over time
as the risk of funding retirement is shifted to individuals instead of cor-
porations. Nevertheless, it behooves investors to take a close look at the
stock of firms with large DB plans as they can be a serious drain on fu-
ture earnings.Standard & Poor’s Core Earnings
The dismay over the treatment of pensions and options and the ever-
widening definition of operating earnings led the Standard & Poor’s cor-
poration in 2001 to propose a uniform method of calculating earnings
that they called core earnings. The objective was to define and measure
earnings from a firm’s principal or “core” businesses and to exclude
from earnings revenues or expenses that are incurred for other reasons.
Core earnings expenses employee stock options, recalculates pension
costs, and excludes unrelated capital gains and losses, goodwill impair-
ments, and one-time litigations gains and losses, among others.
This unusual and bold stance was taken by the nonregulatory, pri-
vate sector firm that is the keeper of the world’s most replicated bench-
mark, the S&P 500 Index. The New York Timescalled it one the best ideas
in 2002.^19 Warren Buffett applauded the S&P’s stance, stating in an open
letter to David Blitzer, managing director of Standard & Poor’s, “Your
move is both courageous and correct. In the future, investors will look
back at your action as a milestone event.”^20CHAPTER 7 Stocks: Sources and Measures of Market Value 107
(^18) This was communicated to me by Howard Silverblatt of Standard & Poor’s in an e-mail on June
5, 2007.
(^19) Tim Carvell, “The Year in Ideas,” New York Times Magazine, December 15, 2002.
(^20) Warren Buffett, open letter to David Blitzer, managing director of Standard & Poor’s, May 15, 2002.