Investors are focusing more than ever on earnings as a sign of Corporate America's financial health and the economy overall as the stock market shows signs of age.
Sharp Fall in GAAP Earnings
But that picture may be far from accurate when it comes to many companies' earnings, according to the Wall Street Journal. Only 29 companies in the S&P 500 index, 5.7% of the total, exclusively used GAAP numbers in their filings compared to 25% in 2006, the Journal said. That's more than a 77 percent decline in the number of companies using only GAAP measures in a decade.
The Journal also found as many as one in 10 companies reported results in adjusted earnings before interest, taxes, depreciation and amortization, a non-GAAP form of accounting. This practice is up four-fold from a decade ago.
To be sure, such non-GAAP metrics are allowed by the SEC and can potentially give a more accurate picture of a company’s performance by stripping out noncash or unusual items, and filings must also include GAAP numbers. But companies can also use non-GAAP metrics to paint a more positive earnings picture than is the case. Earnings fell by 0.1% in last year's third quarter for the largest U.S. companies using Non-GAAP metrics, but they fell 13% using GAAP, according to the Journal. (To read more, see: Mind the GAAP: Buyer, Beware Profit ‘Adjustment’,)
These two companies' earnings benefited handsomely from non-GAAP accounting last year.
Valeant Pharmaceuticals International Inc. (VRX) has been using non-GAAP measures for a number of years, and last year reported a loss of $291.7 million under GAAP measures while showing a profit of $2.84 billion using an adjusted non-GAAP metric.
And LendingClub Corp. (LC) is another example, reporting a GAAP loss of $5 million while earning a non-GAAP net income of $56.8 million in 2015. Other companies getting a boost from using non-GAAP metrics in their January-quarter announcements include Allergan Inc. (AGN), reporting a $3.04 non-GAAP EPS compared to a $0.47 GAAP EPS, and Alphabet Inc. (GOOG), reporting a $7.50 non-GAAP EPS compared to a $6.02 GAAP EPS.
According to the Journal, research conducted by Audit Analytics also suggests that companies who are more reliant on non-GAAP measures tend to have more general accounting flaws, even if the flaws are not directly caused by using non-GAAP metrics. While Audit Analytics suggests more research is needed, the finding concludes that companies using non-GAAP measures may have “less rigorous” accounting standards. (To read more, see: Accounting Basics: Financial Reporting).