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Why Companies Don't Want You To Look At GAAP Earnings

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Two weeks ago, when we did our latest analysis of GAAP and non-GAAP earnings, we were stunned by several findings:


First, consensus Q1 2016 non-GAAP earnings, the kind that even Warren Buffett openly rails against, have imploded from +5% to -8.3% (this was "only" -7.4% two weeks ago), and more than double the -3.4% plunge in Q4 2015 EPS.




Keep in mind that all of the above is on a non-GAAP basis, and if one looks at GAAP earnings, the picture goes from dire to absolutely disastrous.


Second, we said that if one uses I/B/E/S GAAP earnings, which exclude the barrage of pro-forma write offs, addbacks, "non-recurring items" and countless other "misleading numbers that can deceive investors", what one gets is a true shocker: instead of 118 in LTM EPS for the S&P 500 (shown in red in the chart below) the true, Warren Buffett-approved number (shown in blue in the chart bellow) is a paltry 91.5! This is also the lowest S&P500 GAAP earnings per share since 2010, and translates into a 21.2 GAAP PE.




Two weeks later, after the market's recent surge, the market's GAAP PE is now over to 22x.


We then explained what is taking place with the following chart showing the amount of EPS

"writeoffs" and pro-forma adjustments should explain it. "In 2015, 26.5 of the total non-GAAP in S&P earnings, is the result of accounting gimmicks. The addbacks to the S&P's EPS are now the highest since the 2008 financial crisis, and in nominal dollar terms, are already an all time high"






Today, we are delighted to find that Factset itself has taken on this critical distinction between GAAP and Non-GAAP earnings as the core topic of its weekly earnings insight report.


It's finding confirms everything we warned about two weeks ago, and explains why every single company is desperate for investors to look only at its non-GAAP myth, and to stay as far away from the GAAP reality as possible.


Did DJIA Companies Report Higher Non-GAAP EPS in FY 2015?




While all US companies report EPS on a GAAP (generally accepted accounting principles) basis, many US companies also choose to report EPS on a non-GAAP basis. There are mixed opinions in the market about the reporting of non-GAAP EPS by US corporations. Supporters of the practice argue that it provides the market with a more accurate picture of earnings from the day-to-day operations of companies, as items that the companies deem to be one-time events or non-operating in nature are typically excluded from the non-GAAP EPS numbers.Critics argue that there is no industry-standard definition of non-GAAP EPS, and companies can take advantage of the lack of standards to (more often than not) exclude items that have a negative impact on earnings in order to boost non-GAAP EPS.










As of today, all of the companies in the Dow Jones Industrial Average (DJIA) have reported EPS for FY 2015. What percentage of these companies reported non-GAAP EPS for FY 2015? What was the average difference between non-GAAP EPS and GAAP EPS for companies in the DJIA for FY 2015? How did this difference compare to last year?








For FY 2015, 20 of the 30 companies in the DJIA (or 67%) reported non-GAAP EPS in addition to GAAP EPS for the fiscal year.
For 18 of these 20 companies, non-GAAP EPS was higher than GAAP EPS
On average, non-GAAP EPS exceeded GAAP EPS by 30.7% for these 20 companies.
For FY 2014, 19 of the 30 companies in the DJIA (or 63%) reported non-GAAP EPS in addition to GAAP EPS for the fiscal year. For 15 these 19 companies, non-GAAP EPS was higher than GAAP EPS. On average, non-GAAP EPS exceeded GAAP EPS by 11.8% for these 19 companies. Thus, there was a wider gap on average between non-GAAP EPS and GAAP EPS in FY 2015 compared to FY 2014 for companies in the DJIA.








Due in part to this wider gap between non-GAAP EPS and GAAP EPS, companies in the DJIA on average reported a much smaller year-over-year decline in year-over-year EPS on a non-GAAP basis than on a GAAP basis for the year.
For FY 2015, the 20 companies in the DJIA that reported non-GAAP EPS reported an average year-over-year decline in non-GAAP EPS of -4.8%. These same 20 companies reported an average year-over-year decline in GAAP EPS of -12.3%.


So now that we know our math was right, perhaps our punchline from two weeks is correct as well, and it ias follows: "if using GAAP earnings, and applying the market's already generous 16.5x non-GAAP P/E, one gets a fair value of the S&P 500 of 1,500, or over 25% lower than the recent prints in the S&P 500."


Which may explain the unprecedented scramble to pump up both the market, and P/E multiples as high as possible before the trapdoor is opened once again.














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