Earnings at many U.S. companies are falling.
A few brave souls are calling it an “earnings recession.” But that’s not the story that Wall Street and corporate America want to tell investors through mainstream financial media outlets.
Like peacocks, firms want to proudly announce that their earnings “beat the street.”
So with a wink and a nod to Wall Street, and a wave of the magic wand, companies roll out pro forma earnings. Not the old standard, generally accepted accounting principles (GAAP) earnings.
Remind anyone of that line from the Wizard of Oz, “Pay no attention to the man behind the curtain”?
What’s Behind the Curtain
The Wall Street Journal recently revealed a bit of what’s “behind the curtain.”
GAAP earnings showed that S&P 500 companies’ earnings fell by 12.7% in 2015, according to S&P Dow Jones Indices. That was an astonishing 25% lower than the pro forma figures. That was the widest gap since 2008, when companies took a lot of write-offs.
Even Bank of America Merrill Lynch noticed.
In a December 2015 report, its analysts said, “Since late last year, pro forma S&P 500 EPS has exceeded reported GAAP earnings per share (EPS) by more than 30%, well above the ~10% gap for most of 2013 and 2014 and the widest gap since the Financial Crisis.”
Take a look at the chart below.
The scary thing to me is that today nearly 90% of companies are reporting earnings on an adjusted basis. In other words, pro forma earnings.
What exactly are pro forma earnings that companies are trotting out? Supposedly, they’re earnings adjusted for one-time charges. Such as the cost of an acquisition or restructuring charges.
But the problem is that these one-time charges recur every quarter at many firms.
Technology companies seem to be the biggest abusers of this practice. For example, they love to exclude the cost of stock option grants, which is often a big part of compensation.
Do NOT Deposit Another Dollar in Your Bank Account Until You Read THIS
A CIA insider has launched an urgent mission to expose the government’s secret money lockdown plan…
Once you see what could happen next time you go to an ATM, you’ll understand why he’s sending a FREE copy of his new book to any American who answers right here.
Case in point is Wall Street darling Salesforce.com Inc. (CRM). Look at the latest quarter, for example. When one removes the cost of options granted ($159 million) along with some other items, that $130 million in “earnings” turns into a $26 million loss.
Other abusers include serial acquirers such as the now infamous Valeant Pharmaceuticals International Inc. (VRX).
This widespread use of BS earnings affects everyone who invests in stocks. And the most obvious effect is the mispricing of stocks.
Using pro forma earnings, the WSJ reports the market is trading at only 17 times earnings. But using real or GAAP earnings, the stock market is trading at 21 times earnings. The average price-to-earnings (P/E) ratio since the 1870s is 16.6. So instead of fairly valued, the stock market is currently overvalued.
Saying the market is overvalued is not a message Wall Street wants to send out. So GAAP earnings are basically ignored.
But as an investor, you should not ignore GAAP.
The next time you see CNBC saying that a company’s earnings “beat the Street” and all is sunshine and roses, be very skeptical. Most likely, the earnings are pro forma. In other words, Wall Street’s version of “The Big Con.”
As the global economy slows and real earnings drop, Wall Street wants the average investor to ignore all the financial engineering. But be smart.
Companies are required to provide their GAAP earnings in their financial reports by the SEC. But it’s usually hidden in an obscure corner of the report.
Take the time to find it. That way you’ll know what’s “behind the curtain.”