Volume 24, No. 9: Where It Lives In The S&P 500: The Non-GAAP Earnings Epidemic, Part 1
Investors have made adjustments to earnings reports for about as long as earnings reports have existed. In the last few years, it seems to have become much more commonplace. There are a few possible reasons: companies have become more skilled in guiding analysts on earnings expectations, and in doing so, they present guidance without “the bad stuff.” The SEC permits the presentation of non-GAAP earnings in earnings releases, as long as a reconciliation to net income is included – so companies make non-GAAP earnings presentations to match up with their guidance to analysts. Another possible reason: usually, a company’s earnings are going to look more appealing on a non-GAAP basis, and once one company in an industry starts presenting this way, others will copy it so they don’t look worse than their competition. Whatever the reason, the incidence of non-GAAP earnings presentations has exploded for at least the last five years in the S&P 500. It used to be commonplace in the technology and health care sectors, where companies whose earnings were loaded with stock compensation expense and restructuring charges encouraged investors to look the other way, on the grounds that they were “non-cash charges.” Now plenty of non-GAAP earnings presentations are found in every sector. It’s not always a good thing. The more items that companies take out of their earnings, the less comparable one company becomes to another. Investors might not like net income as a metric, but it might just be that they don’t like the story it’s telling. One thing in favor of net income: at least it follows a standard recipe. Non-GAAP earnings are more akin to anarchy. In this report, the spread of the practice in the S&P 500 is examined, and it’s found to be almost the standard practice for reporting earnings in 2014.
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