Volume 25, No. 5: Wonder Bread: Non-GAAP Earnings Keep Rising in the S&P 500, Part II

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This time, it’s a “why” recipe, not to be confused with a “rye” recipe. In our previous study, the focus was on the dollar amount of adjustments made to GAAP net income. In this report, we look at the frequency of adjustments and try to come up with explanations for why there are now so many companies making non-GAAP adjustments in their earnings presentations. No matter how you slice it, the subject is still the “Wonder Bread” reported by companies.

 The spate of non-GAAP earnings presentations since 2009 may be linked to an SEC interpretation of its original regulation guidelines for companies to make such presentations. The road to hell is paved with good intentions: while trying to prevent firms from calling adjustments “non-recurring,” one-time” or “unusual,” it allowed other descriptions to be used. This interpretation may have green-lighted other kinds of adjustments that otherwise might never have been made in typical non-GAAP earnings presentations.

The non-GAAP adjustments to earnings have a kind of “sector signature” – a different dialect, dependent upon a firm’s sector membership. For instance, health care companies make more acquisition activity-related adjustments than firms in other sectors; energy firm, more impairment adjustments; and information technology companies make more intangibles amortization expense and equity-based compensation adjustments than other firms. Here, we sort out the dialects and make suggestions for more comprehensive ways to evaluate performance than simply ignoring expenses that are unflattering to the bottom line.

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