It was business as usual at Fool HQ today, much as it has been for the three weeks the sniper has been on the loose in our area. Though we've managed to carry out our duties, we've done so while trying to suppress fear, anger, frustration, and bewilderment.

Today brought hope, however, that the pre-dawn arrests at a Maryland rest stop will mean an end to the killings. Perhaps we can once again shop and gas up our cars without looking over our shoulders, and our children can now return to the playing fields and look forward to a normal Halloween. Let's pray that's the case.

The day-to-day meanderings of the stock market continue through thick and thin. Today, the FOOL 50 dropped about 1%.

In today's Motley Fool Take:

Pension Plans Shrink Profits

Move over stock options, there's a new issue muddying the investing waters: pension fund costs.

Standard & Poor's today released "core earnings" figures for the companies that make up the S&P 500 index, and the results are a real eye-opener -- and cause the index's P/E ratio to jump dramatically. In calculating core earnings, the organization focuses on "after-tax earnings generated from... principal businesses." And this year, that means properly accounting for stock option grant expenses and pension incomes.

For the 12 months ended June 2002, the index earned $26.74 per share, as reported by the companies themselves. Using the core earnings definition, however, that figure shrinks to $18.48 per share. The most significant impact came from the pension fund adjustment, which knocked $6.54 per share off the $26.74 figure.

Here's the problem: Generally accepted accounting principles (GAAP) allow companies to use expected returns for their pension plans. In most cases, that means 9% or 10% per year. The problem is that's an aggressive assumption, especially in the current environment. S&P's Kenneth Shea told The Wall Street Journal that all but two of S&P 500 companies with traditional pension plans actually suffered investment losses in their funds last year.

So, the S&P core earnings figure uses actual pension fund results, and thus paints a more realistic picture of the index's performance. The impact on basic metrics, such as the P/E ratio, is huge. Using "as-reported" figures, the S&P 500 is trading at 37 times trailing-12-month earnings. But using core earnings, the P/E jumps to 54.

Of course, to place that number in proper context, we'd need historical data that used the same methodology, but that's not available now. Regardless, the S&P core earnings figure points out, once again, how dangerous it can be to evaluate companies using only easily manipulated GAAP figures. As always, we recommend free cash flow, which cannot easily be faked.

Quote of Note

"Experience is not what happens to you; it's what you do with what happens to you." -- Aldous Leonard Huxley (1894-1963), English novelist and essayist

Earnings Version 2.0

Like an America Online busy signal circa 1996, it took awhile to get connected. But the truth at AOL Time Warner(NYSE: AOL) finally got through, as it announced it had overstated revenue by $190 million and pretax cash flow by $97 million over the last two years.

This comes after an internal review turned up accounting inaccuracies in the way it recorded some advertising and commerce transactions. While the amount is significant, the restatement itself was not a surprise, as AOL Time Warner's integrity had been hounded by SEC allegations.

The company also reported earnings of $0.19 a share before charges for the third quarter. While that was a nickel off last year's showing, it was in line with Wall Street expectations. It continues to be dogged by weakness at its America Online service, where ad revenue fell for the fourth consecutive quarter.

Nailing watered-down projections and taking a vat of correction fluid to past financials might not amount to much of a moral victory, but the investing community is taking the news well. The stock traded a buck higher in after-hours trading yesterday, on the heels of the report.

With the stock trading for less than what the company paid for all of Time Warner two years ago, the gray clouds may finally be passing for AOL, as investors begin to value the conglomerate's vast assets at a time when entertainment is a necessary commodity.

Discussion Board of the Day: AOL Time Warner

Do you believe in forgiving and forgetting when a company restates past earnings, or does that turn you off forever? What will it take to turn America Online around? All this and more -- in the AOL Time Warner discussion board. Only on

The Actively Managed Trap

We've heard it before, and we'll hear it again, because not everyone has gotten the message. It's very difficult for actively managed mutual funds -- those funds run by a team of analysts and managers who pick the investments -- to beat the overall stock market.

This is once again emphasized in a new tome, The Great Mutual Fund Trap: An Investment Recovery Plan. Written by Gregory Baer and Gary Gensler, former U.S. Treasury officials, the book argues that actively managed funds cannot overcome trading fees, management expenses, sales commissions, and marketing budgets.

According to Baer and Gensler, the 1,226 actively managed stock funds with a five-year record by the end of 2001 posted an average return of 8.8% a year -- 1.9 percentage points behind the Standard & Poor's 500. The 623 actively managed stock funds with a 10-year record returned 11.2% annually, on average, vs. 12.9% for the S&P 500.

This doesn't count funds that operated during those time periods but were closed, usually due to poor performance. The authors argue that this "survivorship bias" hides the fact that the average actively managed mutual fund underperforms the market by approximately three percentage points a year.

Want more stats? The average actively managed fund underperforms the market three out of every five years. And guess how many funds have beaten the S&P 500 each of the past 10 years. Just one: the Legg Mason Value Trust.

The Great Mutual Fund Trap likens trying to beat the market to flipping a coin and hoping to always get "heads," as shown in this excerpt (courtesy of BusinessWeek):

Imagine, then, the Coin Flipping News Network (CFNN), giving us 24-hour daily coverage of the flipping market. In comes coin-flipper Lee with 56 heads, touting her latest tactic -- say, many revolutions of the coin, with three taped together. Long forgotten is last week's guest, who had favored the few-revolution, one-coin-at-a-time tactic that worked so well during the last 500 flips but is now seriously out of favor. "Momentum" viewers prefer those who have recently had more heads, while "value" viewers like those who have recently had more tails.

Above all, viewers are assured that they are not capable of flipping the coins themselves -- that they must rely on the experts to do it for them. And they are convinced that they should never be satisfied with just 50% heads -- that is, "market" performance.

What's the solution? Indulge in the simplicity and cost-effectiveness of an index fund. It doesn't try to outperform the market, which means it won't grossly underperform it -- a feat accomplished by few actively managed funds.

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Quick Takes

Earnings, earnings, earnings. Restatements. And more earnings. For a Foolish Take on them, don't miss Rex Moore (TMF Orangeblood) today in Beware False Profits!

Bristol-Myers Squibb (NYSE: BMY) announced a $2 billion restatement of earnings, likely to lower EPS for 2000 and 2001, but raise them for 2002. Go figure. Over several quarters, the company offered sales incentives to boost end-of-quarter shipments to wholesalers. Bristol's Q3 announcement shows that, sooner or later, channel stuffing catches up to you. Before the restatement, Q3 EPS was down to $0.16 from a year-ago $0.63. Ouch. Bristol also said its SEC Form 10-Q will be delayed.

Wireless service provider Nextel(Nasdaq: NXTL) reported a Q3 profit -- its second in a row -- based on more subscribers and equipment sales. But it still has two problems: It's the sole user of iDEN wireless communication technology, supplied only by Motorola(NYSE: MOT), and it has yet to announce a technology choice for system upgrades to faster data (2.5G, 3G, squeegee) speeds. Nextel stock closed today at about $10, close to four times its 52-week low, $2.78, on July 2.

Photo king Eastman Kodak(NYSE: EK) released quarterly earnings today, with EPS doubling and operating cash flow up 7.5% over the year-ago period on a 1% sales increase. The cash flow number would've been almost doubled, too, if it weren't for the change from quarterly dividend payment to semi-annually. The company's comprehensive extensive .pdf file at its website's investors center earns Eastman Kodak an "A" for releasing all three major financial statements -- balance sheet, income statement, and cash flow statement -- at earnings announcement time. It will also cut up to 3% of jobs by year end.

Earnings flowed apace, with bad news from Duke Energy(NYSE: DUK), Tyco(NYSE: TYC), and several big oil producers, balanced by positive reports from huge insurer American International Group(NYSE: AIG) and Wendy's(NYSE: WEN). You can find the reports at our Quotes & Data monster. Just type in the stock ticker, and click on "News."

And Finally...

Today on David Gardner confesses his feelings about Martha Stewart.... Rex Moore warns that profits aren't always what they seem.... Tom Jacobs wonders if homebuilders are cyclical or solid long-term investments.... Humorous tips to straighten your family finances, from Rich Pliskin.... In Fool's School, how to decode financial statements.... Is a turnaround in office real estate pending? The Fool Community weighs in.... And the Post of the Day: Berkshire Hathaway.

Bob Bobala, Robert Brokamp, Tom Jacobs, LouAnn Lofton, Bill Mann, Selena Maranjian, Rex Moore, Rick Munarriz, Matt Richey, Jackie Ross, Reggie Santiago, Dayana Yochim