Volume 22, No. 11

Non-GAAP Earnings: "Nothing Succeeds Like Excess":  That quote is attributed to Oscar Wilde, but it could just as well be attributed to Wall Street. Non-GAAP earnings  began as a way for investors to scrape the muck off of inscrutable income statements, and now non-GAAP earnings are presented by many firms as the only performance measure that matters. When a magician tells the audience to watch his hands, they should know they’re about to be deceived by his next actions. Similarly, investors should be more skeptical when firms direct them to look at non-GAAP measures, whether they be earnings before interest, taxes, and depreciation & amortization (EBITDA), adjusted EBITDA or whatever the metric du jour may be.

Another quote fits the situation aptly: “the road to hell is paved with good intentions.” The non-GAAP earnings trend began with investors trying to sift some form of truth out of opaque income statement reporting – one set of good intentions. When abuses in company presentations became too much to tolerate, the SEC set down guidelines for non-GAAP earnings presentations – another set of good intentions, but one that may have inadvertently legitimized non-GAAP reporting. By coloring inside the lines drawn by the SEC, companies may feel safer in making presentations of non-GAAP earnings, and less timid about joining their competitors already reporting this way.

Presented here are the situation’s origins, some examples of current practice in the technology and health care sectors, and some thoughts about when non-GAAP earnings have a place in the investors’ tool kit – and when they should be avoided.

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