Volume 25, No. 4: Wonder Bread: Non-GAAP Earnings Keep Rising in the S&P 500
And it’s a lot of dough; you’d think investors would be full by now. They’ve long made adjustments to earnings because generally accepted accounting principles give firms accounting choices leading to differences in reported income between two companies, even on a full-GAAP basis. Investors and analysts try to compensate for those differences when they can. Firms now eagerly help investors make adjustments, feeding them fluffy “Wonder Bread” non-GAAP earnings.
Non-GAAP earnings won’t necessarily help investors with comparability. An analyst might like to compare earnings if say, two banks were using the same loan loss reserving principles. Non-GAAP earnings presented by banks aren’t going to show this – but they’re likely to show earnings as they would have appeared without restructuring charges or litigation expenses for the period. Those adjustments can be useful, but can backfire if used to excess.
Non-GAAP earnings have progressed to the point where there are so many variations on the theme that nobody is singing from the same hymnal. One firm’s “adjusted net income” might sound like another firm’s “adjusted net income” –the items included in their non-GAAP recipe might have similar captions – but what goes into those line items could be very different. Those kinds of differences cannot routinely be undone by investors and analysts. Furthermore, any GAAP sins in net income – premature revenue recognition, or overcapitalized costs, for example – aren’t going to be neutralized in non-GAAP earnings measures. While GAAP net income is audited annually, not even annual non-GAAP earnings is an audited figure. It’s a hash made from pieces of the audited income statement, and investors can’t always see the ingredients. Here, we look at the current state of non-GAAP reporting – and suggest ways for investors to reduce their Wonder Bread intake.