Corporate earnings are a mess, which says nothing about where stocks go from here
GAAP earnings are those that follow Generally Accepted Accounting Principles while pro forma, or "adjusted" earnings, exclude one-time items or charges that management determines should be viewed as taken outside the normal course of business.Managements argue that these adjusted figures give investors a "true" picture of how its underlying business is performing. Many skeptics in the market have begun arguing that this is merely a way for executives to hide the truth about their business from investors.
Much of the divide between GAAP and adjusted earnings last year has been attributed to the decline in oil prices which deeply pressured companies in that sector. In 2015, earnings in the S&P 500's energy sector fell about 60%.
In his analysis, Parker found that just 20 companies in the S&P 500 accounted for about half of the GAAP/adjusted earnings spread with 50 companies accounting for 84% of this divergence. Parker added that five companies explain 32% of this spread while representing just 5% of the S&P 500's total earnings.And so on this basis, it looks like this was indeed a limited phenomenon and not something to worry about.
But as we've written, corporate earnings are not so much a science as an art.
Stock-based compensation, for example, is often excluded as a one-time item. Yet issuing more stock is dilutive to existing shareholders, and if the reason for owning stock in a company is to get a percentage of its profits over time, adding shareholders to the mix decreases the value of your holding. This, then, would seem to be an item a common stock owner would not want to ignore.In my view, the real importance of adjusted earnings is that they provide management with the numerical firepower to effectively argue their case for what the company should be worth using data available to them. (Investors, in contrast, get to argue this case in the market.)
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