This report is one of a series on the adjustments we make to GAAP data so we can measure shareholder value accurately. This report focuses on an adjustment we make to our calculation of economic book value and our discounted cash flow model.

We’ve already broken down the adjustments we make to NOPAT and invested capital. Many of the adjustments in this third and final section deal with how adjustments to those two metrics affect how we calculate the present value of future cash flows. Some adjustments represent senior claims to equity holders that reduce shareholder value while others are assets that we expect to be accretive to shareholder value.

Adjusting GAAP data to measure shareholder value should be part of every investor’s diligence process. Performing detailed analysis of footnotes and the MD&A is part of fulfilling fiduciary responsibilities.

In their annual reports, companies disclose the value of the assets used to fund their pension plans and the present value of the future obligation, called the projected benefit obligation. The net funded status of a pension plan is the difference between these two values. A company with a positive net funded status has more assets than they need in their plan, which means future cash flows that would have been used to meet new obligations can instead be returned to shareholders. Companies with underfunded pensions will likely need to divert a greater amount of future cash flows away from shareholders to make up the funding gap. An accurate analysis of shareholder value should include the net funded status of pensions.

The Washington Post Company (WPO) is one of only a few publicly traded companies that have a net positive funded status for its pension plans. The company’s three pension and post-retirement plans are currently overfunded by $437 million. Jeff Bezos may not be getting much in the way of profits from his acquisition of The Washington Post newspaper (which is one segment of the company), but at least he won’t be taking on any pension liabilities.

Without careful footnotes research, investors would never know that the pension net funded status can increase or decrease the amount of future cash flow available to shareholders.

Figure 1 shows the five companies with the largest overfunded pensions added to shareholder value in 2012 and the five companies with the largest underfunded pensions in 2012.

Figure 1: Companies With the Largest Pension Under/Over Funding Removed From/Added To Shareholder Value

Sources: New Constructs, LLC and company filings

The ten companies in Figure 1 are far from the only companies that are affected by the net funded status of pension plans. In 2012 alone, we found 45 companies with overfunded pensions totaling over $5.3 billion and 1,096 companies with underfunded pensions totaling over $811 billion. Companies clearly prefer to leave their pensions underfunded in order to boost short-term profits by committing cash elsewhere.

Since underfunded pensions decrease the amount of cash available to be returned to shareholders, companies with significant pension underfunding will have a meaningfully lower economic book value when this adjustment is applied. General Motors is one of the worst offenders for underfunded pensions. GM’s pension and post-retirement plans have $84 billion in assets and $119 billion in projected benefit obligations.

Without removing the $35 billion in pension underfunding on GM’s books, the company would have a price to economic book value ratio of 1.1, which we classify as Very Attractive. Removing that $35 billion increases the ratio to 4.3, which qualifies as Very Unattractive.

Investors who ignore over and under funded pensions are not getting a true picture of the cash available to shareholders. Diligence pays.

Sam McBride contributed to this report.

Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, or theme.

    2 replies to "Pension Net Funded Status – Valuation Adjustment"

    • Andrew

      One factor you are not considering is the discount rate used to calculate pension funding. Right now interest rates are low so many companies are using a discount rate around 4%. As that rate rises, underfunded status will decrease dramatically. That’s why it is often good to be a little bit underfunded when bonds are expensive.

    • Steve Cushing

      To quote Doug Noland (Credit Bubble Bulletin blog): “Massive federal deficits and low Fed-dictated borrowing costs sustain inflated corporate earnings and cash-flows.” Mr. Trainer, how do you reconcile the results of your methodology with government-induced, massively-inflated corporate earnings and cash flows – both economic and accounting?

      I remember, about seven years ago, on the website fool dot com, coming across a mention of the book “Expectations Investing” by Mauboussin and thinking how intriguing that valuation method was. The calculations required were beyond my capabilities to execute at the time, and still are. So I was impressed to see that your website incorporates his thinking in regards to what “growth expectations are embedded in the price”. Prior to re-discovering your website last week, I was leaning to “free cash flow” as being the most important metric. After reading your website, I see that ROIC is a better over-all metric.

      New Constructs is a national treasure. Seriously.


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