posted on 28 March 2016
by Diane Alter
A growing number of Wall Street experts have become increasingly critical of companies highlighting adjusted earnings. Also known as non-GAAP, these adjusted earnings are repeatedly being used to deceive investors...
Here's how non-GAAP earnings differ so dramatically from GAAP earnings...
GAAP is short for Generally Accepted Accounting Principles. GAAP accounting standards provide uniformity in how companies report their financial performance.
But income statements based on GAAP don't always accurately reflect the ongoing performance of a company's underlying operations.
For example, a company may write-down an asset or restructure its organization. Those actions are usually accompanied by significant one-time costs that distort company profits. In such cases, a company will also provide "adjusted" earnings, or non-GAAP numbers. These non-GAAP numbers exclude one-time items.
That's why when looking at S&P 500 earnings, we only care about GAAP numbers. Non-GAAP numbers don't provide a clear (if any) indication of the true financial state of the company.
Many argue non-GAAP is really nothing more than a tool used by management to raise capital, the company's stock price, or stock-linked executive compensation.
Money Morning Capital Wave Strategist Shah Gilani says make no mistake, non-GAAP earning methods are simple manipulation.
There are times when non-GAAP, or adjusted earnings, are warranted. Maybe when earnings are substantially impacted by merger or acquisition costs, restructuring charges, goodwill write-downs, asset impairment charges, or other supposed one-time charges.
But according to Gilani, there's a major problem because some companies seem to keep incurring these "one-time" charges. And even though they are repeated, they frequently end up in non-GAAP accounting.
It's become a major problem because the difference between non-GAAP and GAAP earnings is stark...
For all of 2015, S&P 500 non-GAAP 12-month trailing earnings came in at $118. GAAP earnings, meanwhile, were $87 for 2015.
According to FactSet, Dow Jones Industrial Average components that reported non-GAAP earnings per share last year posted earnings that were on average 30% above earnings per share under GAAP.
The massive distortion makes the uneven U.S. economic recovery more pronounced. But there is a way for investors to protect themselves from this repeated Wall Street deception...
Protect Yourself from Non-GAAP Market Manipulation Now
With more and more companies relying on non-GAAP results, regulatory scrutiny has heightened.
Last week, the U.S. Securities and Exchange Commission said it's mulling whether to curb some of the freedom firms enjoy to provide adjusted earnings figures.
SEC Chairman Mary Jo White said at a conference of finance and business lobbyists in Washington:
Yet it's unclear when the SEC will actually implement new measures restricting non-GAAP results.
In the meantime, Gilani advises investors to keep raising their stops so they can book profits when the markets head back down.
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