Volume 23, No. 11

Non-GAAP Earnings: How They Have Grown:  Non-GAAP earnings are a double-edged sword. When they cut on the good side, they scrape away the one-time events obscuring a firm’s operating performance: items like asset write-downs and restructuring charges provide much information about management stewardship of a firm over the long run, but their recognition hides the firm’s quarterly performance when they’re reported. Excising them from the earnings doesn’t have to be the same as forgiving them.

 When non-GAAP earnings cut on the bad side, they scrape away more than one-time events: they scrape away routine expenses as well. Expenses commonly ignored in non-GAAP earnings presentations have come to include ordinary, routine expenses like intangibles amortization and executive stock compensation. Those expense “cuts”are often justified on the grounds that they’re non-cash expenses, and therefore somehow not real. Worse: when investors start buying into that premise, they also start believing that the non-GAAP presentation actually reflects the firm’s cash generation – but those measures are hardly ever a robust measure of cash generation.

 Occasionally, non-GAAP earnings are criticized in the financial press when an initial public offering uses a measure that seems particularly egregious. The broad investor acceptance of alternative measures the rest of the time says several things. One: some investors will accept anything companies tell them, as long as everyone else accepts it. Two: if companies go to great lengths to modify earnings as presented by generally accepted accounting principles, maybe the current income statement presentation needs improvement by standard setters.

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