Ryan Frederick  by Ryan Frederick
  Equity Analyst, Gradient Analytics LLC (a Sabrient Systems company)

In 2003, the SEC first officially adopted rules (following Sarbanes-Oxley in 2002) related to the reporting of non-GAAP financial metrics. The new regulations called for a reconciliation of GAAP versus non-GAAP results to be included in various investor resources and to refrain from excluding non-recurring items from non-GAAP metrics if they are reasonably likely to reoccur, which is subject to wide interpretation. Since then, it seems the perceived importance among investors of non-GAAP financial performance has been elevated above traditional GAAP measures. Between 2015 and 2017, less than 10.0% of companies in the S&P 500 did not report a non-GAAP income calculation. However, the ability for management to subjectively decide what is or is not relevant to a company’s core business leaves plenty of room for earnings manipulation.

On the one hand, companies tend to justify their exclusion of various transactions as necessary for “comparability” to historical results, given that GAAP rules have changed over time. Fair enough. However, when an investor chooses to rely upon non-GAAP results when comparing a given company’s results to another’s, the comparisons can be deeply misleading as management has great leeway for subjective (and sometimes ad-hoc) adjustments in their exclusions – i.e., what one company concludes should be excluded in a non-GAAP calculation may not be consistent with what another company may exclude.

In fact, in 2010 former SEC chief accountant Howard Scheck identified non-GAAP performance metrics as a “fraud risk factor.” The SEC even created a taskforce to analyze non-GAAP earnings metrics that could be misleading. Then, in an effort to provide more clarity, the commission provided Compliance and Disclosure Interpretations (C&DIs) which detailed ways in which the SEC may find non-GAAP disclosures to be misleading, but more on that later.

Here at Gradient Analytics, our focus on earnings quality analysis (for both short idea generation and vetting of long candidates) regularly includes an examination of non-GAAP adjustments to determine whether they are appropriate in helping represent the true performance of the firm, or whether they are misleading. There is a plethora of unique adjustments a company could make to a non-GAAP income calculation; however, some are more common than others. One of the more frequent adjustments to GAAP income is the exclusion of restructuring costs. Read on….

The abundance of news last week -- most with a positive slant -- finally boosted the S&P 500 out of the Channel of Gloom in which it was mired for so long. Not only did the S&P 500 break out of the channel, but it is now threatening the 200-day moving average, having surpassed the 50-day MA last week.

david / Tag: AAPL, AET, AFL, AMZN, BA, CIT, F, FCFS, FDX, GOOG, IBM, LVS, MOT, MRK, MS, NTSC, RGR, S, sectors, SNE, TESS, V, XOM / 0 Comments

Last week, the market was very selective, with only Large-cap Growth in positive territory -- think Apple (Nasdaq: AAPL), Amazon (Nasdaq:  AMZN), and American Express (NYSE: AXP). All other cap/styles were negative -- and the smaller you were, the more you lost. In fact, this entire month the market has beat up on small-caps with its "the smaller you are, the more you lose" bias.

david / Tag: AAPL, AMZN, AXP, BA, CapMark, energy, healthcare, HOGS, KMGB, KVA, NTRS, sectors, TEX, USG / 0 Comments