Corporations Don't Want to Report Their True Earnings. Why is The Financial Press So Eager to Help?
I totally understand why corporations may wish to push the envelope on earnings adjustments to make their stock look like a better buy. But why is the financial media generally complicit with this? Take any earnings announcement you read about or hear on the TV -- almost every single time it turns out that the earnings number quoted by the press, at least in the headline or the TV sound bite, is the company's non-GAAP adjusted number, not their actual GAAP number.
I might be OK with this if this were being done for good reasons, ie if the financial press thought the adjusted number was somehow more representative. But I don't get this sense at all. It feels more like the press is just lazy and accepts whatever number is in the press release without digging further. Often in a longer story you will find the GAAP number, but buried many grafs in.
Oh, and by the way, the two numbers are diverging:
A good way to think about this chart is that, if you are not careful, you are paying for the bar on the right but getting the bar on the left. Note that without adjustments, earnings fell pretty substantially in 2015. It is not at all clear to me why we have not seen this story.
stan:
Students go into journalism because they've been told there won't be any math on the tests. Based on the descending quality of today's news reporting, logic seems to have been removed from the curriculum as well.
February 29, 2016, 12:28 pmOrion Henderson:
I don't really know how big corps do earnings, but when I adjust my earnings I want them to go down to lower my taxable income. Adjustments are for inventory, depreciation, etc. Could it be that companies are more aggressively managing those things?
I've never worked for a big company so I really don't have any first hand understanding of this. It just seems to me that adjusting earnings down is desirable. Of course, the job of the business press should be to figure this out.
February 29, 2016, 1:15 pmMatthew Slyfield:
" It just seems to me that adjusting earnings down is desirable. Of
course, the job of the business press should be to figure this out."
Perhaps true, but corporations typically adjust earnings up, not down.
The driver for this is simple.
The two major measures of CXO performance and hence drivers of their bonuses are share price and earnings per share. On top of that many CXOs, particularly CEOs make more in stock options than in salary. For those stock options to be worth much, the share price must go up.
Investors want to see high earnings per share. If EPS falls below prior quarters, Share price declines and CXOs take a hit in the wallet.
February 29, 2016, 1:26 pmMatthew Slyfield:
Logic is a specialized branch of mathematics.
February 29, 2016, 1:26 pmjimcraq:
A lot of reporting is just passing on the press release. Look at their reporting of any issue with which you have personal knowledge.
February 29, 2016, 5:27 pmBram:
The job of corporate finance is, to the extent possible and legal, SMOOTH out earnings. They typically want to avoid big swings up or down - so earnings in a really good quarter are tucked away or thrown up against bills and R&D, while those expenses are delayed or hidden when sales take a dip.
March 1, 2016, 6:42 amJeff:
I used to write research on public companies... they use non-GAAP earnings because that's what virtually all fund managers want to see. GAAP is riddled with items which obscure the real underlying results for the quarter (in particular stock based compensation costs, but also non-cash charges, one time adjustments to the balance sheet, random tax and other items), so if you run a model using GAAP there will be large fluctuations which lead you to think a particular quarter was unusually good or bad. Most funds/investors wanted the non-GAAP which is more stable over time (since the CFO will always include the same types of things), then they would look at the GAAP results to see if there were particular issues of concern.
I remember back when GAAP was implemented. There was a huge collective groan among CFOs, funds, and analysts, because the government was forcing everyone to present earnings that often had little to do with how the company performed, and which were often difficult to understand. Of course, the positive element is that it helps prevent more Enrons.
March 1, 2016, 9:59 amIan:
There's a difference between tax accounting (what Orion's referring to) and financial accounting (what Matthew and the overall post are referring to). It is very possible, indeed common, for taxable earnings to be different from financial (GAAP or otherwise) earnings. You can see the effect of the difference on public companies' (or private companies', if you have access to them) GAAP financial statements; it shows up on the Balance Sheet as a "Deferred Tax Asset" or "Deferred Tax Liability," depending on how the accounting is different.
Companies want their taxable income as low as possible, to minimize taxes, and their reportable income as high as possible, to maximize EPS, so they employ the two different accounting procedures for the two different reasons.
March 1, 2016, 10:33 amkevinsdick:
+1 Accounting is actually a really complicated discipline. In grad school, a roommate's wife was getting her PhD in accounting at Stanford while I was doing decision theory. We had some very nerdy discussion because there's actually a lot of ornate game theory in developing accounting rules. My take away was that it boils down to something like the classic Type I-Type II tradeoff in statistics or bias-variance tradeoff in predictive modeling. In accounting there's a tradeoff in sensitivity to fraud vs accurately capturing performance.
March 1, 2016, 11:06 amCraig Loehle:
If they do investigative reporting, they won't get interviews and inside stories, just like political reporters won't be invited on the campaign bus if they are critical. It is Faustian bargains all around.
March 2, 2016, 8:51 am