We’ve been sounding the alarm on non-GAAP earnings for several years now. Companies exploited the wide leeway granted by the SEC to present their business in a more favorable light.
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Companies usually pitch these alternative metrics as “supplementary” data to help investors get a “better” view of the profitability of the business. Instead, we see red flags, not a better view.
The “Analyst Notes” column on the stock screener at newconstructs.com features insights into corporate events or disclosures that cause us to question the validity of a company’s financial reporting or the efficiency of the market for its stock.
The Financial Accounting Standards Board (FASB) issued a new set of standards for revenue recognition along with the International Accounting Standards Board (IASB) on Wednesday.
GAAP financial statements generally fail to meet equity investors’ analytical needs. We try to calculate something that does.
On August 27th, I met with my fellow members of the FASB’s Investor Advisory Committee (IAC) to discuss the proposed treatment of operating leases on the balance sheet by the Financial Accounting Standards Board (FASB).
We subtract net deferred tax liabilities (DTLs minus DTAs) from our calculation of shareholder value as they are real future cash obligations that limit the amount of money available for distribution to shareholders.
Overfunded pension assets are similar to excess cash, and should not be included in the calculation of return on invested capital (ROIC).
EPIQ Systems (EPIQ) is in the Danger Zone this week. The legal technology solutions provider has misleadingly high reported earnings due to a funny accounting rule. Analysts and investors looking at reported earnings have assigned unreasonably high expectations to EPIQ.
Most investors would never know that discontinued operations distort GAAP numbers by over-stating assets on balance sheets and distorting the picture of a company’s ability to generate a return on that capital.
Investors who ignore off-balance sheet debt are not holding companies accountable for all of the capital invested in their business. By adding back off-balance sheet debt to invested capital, one can get a true picture of the value that management is creating for shareholders. Diligence pays.
Converting GAAP data into economic earnings should be part of every investor’s diligence process. Performing detailed analysis of footnotes and the MD&A is part of fulfilling fiduciary responsibilities.
I do not think so. The question, however, is not so much about what directors ignore. You cannot ignore something about which you are unaware.
The real issue is that most directors and investors are simply unaware of the many one-time items because they are buried deep in the annals of footnotes in annual reports or 10-K filings.
Accounting data was not designed for equity investors, but for debt investors. “Earnings, earnings per share and earnings growth are misleading measures of corporate performance.”(from page 66 in The Quest For Value by Bennett Stewart, Harper Collins 1991.)
Overall, the Risk/Reward of investing in Yahoo’s stock looks Very Dangerous to me. There is lots of downside risk given the Misleading Earnings and there is little upside reward given the already-rich expectations embedded in the stock price.
Hidden Gem – GPS: economic earnings are rising faster than reported accounting earnings b/c the company lowered the capital employed to run the business. GAAP earnings do not capture increase capital efficiency of the business.
TheStreet.com recently published three articles quoting me on SIRI. Andrea Tse called and, after reviewing our models on SIRI, I told her that the stock was Dangerous because:
There are two primary reasons a stock gets on our Most Dangerous List:
1. Misleading earnings: reported GAAP earnings are positive and rising while economic earnings are negative and declining
2. Expensive valuation: future cash flow expectations embedded in the current price are unusually high especially compared to historical performance.
Free copy of our report on NYX is in the Free Archive on www.newconstructs.com. Or just click here: NYX Company Valuation Report.