Volume 26, No. 4

Over-explained Earnings: Current Non-GAAP Earnings Trends in the S&P 500:   Investors have long concocted earnings adjustments because they want earnings from one company to be more comparable to those of another, or to make a company’s current earnings comparable to the earnings of a prior year. It’s an exercise in reading earnings reports and paying attention to details, and an exercise that forces diligence upon investors.

             Fair enough. But firms have gotten into the act with identifying adjustments first: it’s as if the food for investors is being pre-chewed for them, and they gobble it down like baby birds. Quarterly reporting of non-GAAP earnings has evolved into a case of robust “over-explaining:” there’s always a reason for an expense to be ignored, and the count of adjustments keeps growing. The corporate over-explaining is a discrete phenomenon: Non-GAAP earnings don’t help investors equilibrate earnings of one company to another, affecting only a firm’s own time-series comparability. There’s some value in comparing two firms’ earnings and margins without, say, a restructuring charge in both sets of figures. Beyond that kind of expense redaction, non-GAAP earnings presentations don’t help much in refining inter-company comparisons.

             Sometimes an expense is just an expense - simply a cost of doing business, not something to be excused on the grounds that it interfered with an earnings target or “earnings potential.” Over-explaining the way expenses were incurred leads to unrealistic expectations about profitability, and distracts investors from probing deeper into the GAAP figures. Often derided in the press and the subject of intensified SEC scrutiny, the number of firms presenting non-GAAP net income abated somewhat at the end of 2016. Less surprisingly, however, the number of adjustments in non-GAAP earnings presentations increased. In this report, we look at the current trends in non-GAAP reporting at the end of 2016.

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