From Non-GAAP To Non-Sense: David Stockman Slams The "Earnings Ex-Items" Smoke-Screen

Tyler Durden's picture

We noted on Thursday, when Alcoa reported, that "non-recurring, one-time" charges are anything but; indicating just how freely the company abuses the non-GAAP EPS definition, and how adding back charges has become ordinary course of business. But it's not just Alcoa, and as David Stockman, author The Gret Deformation, notes Wall Street’s institutionalized fiddle of GAAP earnings made P/E multiples appear far lower than they actually are, and thereby helps perpetuate the myth that the market is "cheap."


Via David Stockman,


One of the reasons that the monetary politburo was unconcerned about the blatant buying of earnings through financial engineering is that it fully subscribed to the gussied-up version of EPS peddled by Wall Street. The latter was known as “operating earnings” or “earning ex-items,” and it was derived by removing from the GAAP (generally accepted accounting principles)- based financial statements filed with the SEC any and all items which could be characterized as “one-time” or “nonrecurring.”

These adjustments included asset write-downs, goodwill write-offs, and most especially “restructuring” charges to cover the cost of head-count reductions, including severance payments. Needless to say, in an environment in which labor was expensive and debt was cheap, successive waves of corporate downsizings could be undertaken without the inconvenience of a pox on earnings due to severance costs; these charges were “one time” and to be ignored by investors.

Likewise, there was no problem with the high failure rate of M&A deals. In due course, dumb investments could be written off and the resulting losses wouldn’t “count” in earnings ex-items.

In short, Wall Street’s institutionalized fiddle of GAAP earnings made PE multiples appear far lower than they actually were, and thereby helped perpetuate the myth that the market was “cheap” during the second Greenspan stock market bubble. Thus, as the S&P 500 index reached its nosebleed peaks around 1,500 in mid-2007, Wall Street urged investors not to worry because the PE multiple was within its historic range.

In fact, the 500 S&P companies recorded net income ex-items of $730 billion in 2007 relative to an average market cap during the year of $13 trillion. The implied PE multiple of 18X was not over the top, but then it wasn’t on the level, either. The S&P 500 actually reported GAAP net income that year of only $587 billion, a figure that was 20 percent lower owing to the exclusion of $144 billion of charges and expenses that were deemed “nonrecurring.” The actual PE multiple on GAAP net income was 22X, however, and that was expensive by any historic standard, and especially at the very top of the business cycle.

During 2008 came the real proof of the pudding. Corporations took a staggering $304 billion in write-downs for assets which were drastically overvalued and business operations which were hopelessly unprofitable. Accordingly, reported GAAP net income for the S&P 500 plunged to just $132 billion, meaning that during the course of the year the average market cap of $10 trillion represented 77X net income.

To be sure, after the financial crisis cooled off the span narrowed considerably between GAAP legal earnings and the Wall Street “ex-items” rendition of profits, and not surprisingly in light of how much was thrown into the kitchen sink in the fourth quarter of 2008. Even after this alleged house cleaning, however, more than $100 billion of charges and expenses were excluded from Wall Street’s reckoning of the presumptively “clean” S&P earnings reported for both 2009 and 2010.

So, if the four years are taken as a whole, the scam is readily evident. During this period, Wall Street claimed that the S&P 500 posted cumulative net income of $2.42 trillion. In fact, CEOs and CFOs required to sign the Sarbanes-Oxley statements didn’t see it that way. They reported net income of $1.87 trillion. The difference was accounted for by an astounding $550 billion in corporate losses that the nation’s accounting profession insisted were real, and that had been reported because the nation’s securities cops would have sent out the paddy wagons had they not been.

During the four-year round trip from peak-to-bust-to-recovery, the S&P 500 had thus traded at an average market cap of $10.6 trillion, representing nearly twenty-three times the average GAAP earnings reported during that period. Not only was that not “cheap” by any reasonable standard, but it was also indicative of the delusions and deformations that the Fed’s bubble finance had injected into the stock market.

In fact, every dollar of the $550 billion of charges during 2007–2010 that Wall Street chose not to count represented destruction of shareholder value. When companies chronically overpaid for M&A deals, and then four years later wrote off the goodwill, that was an “ex-item” in the Wall Street version of earnings, but still cold corporate cash that had gone down the drain. The same was true with equipment and machinery write-off when plants were shut down or leases written off when stores were closed. Most certainly, there was destruction of value when tens of billions were paid out for severance, health care, and pensions during the waves of headcount reductions.

To be sure, some of these charges represented economically efficient actions under any circumstances; that is, when the Schumpeterian mechanism of creative destruction was at work. The giant disconnect, however, is that these actions and the resulting charges to GAAP income statements were not in the least “one time.” Instead, they were part of the recurring cost of doing business in the hot-house economy of interest rate repression, central bank puts, rampant financial speculation, and mercantilist global trade that arose from the events of August 1971.

The economic cost of business mistakes, restructurings, and balance sheet house cleaning can be readily averaged and smoothed, an appropriate accounting treatment because these costs are real and recurring. Accordingly, the four-year average experience for the 2007–2010 market cycle is illuminating.

The Wall Street “ex-item” number for S&P 500 net income during that period overstated honest accounting profits by an astonishing 30 percent. Stated differently, the time-weighted PE multiple on an ex-items basis was already at an exuberant 17.6X. In truth, however, the market was actually valuing true GAAP earnings at nearly 23X.

This was a truly absurd capitalization rate for the earnings of a basket of giant companies domiciled in a domestic economy where economic growth was grinding to a halt. It was also a wildly excessive valuation for earnings that had been inflated by $5 trillion of business debt growth owing to buybacks, buyouts, and takeovers.

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Oldwood's picture

Judging from my limited perspective, if corporations are making money, it must becoming through fraud or a general fucking of those left trying to stay afloat. None of it makes sense.

rehypothecator's picture

I made a billion dollars last year, ex- a one-time expense of somewhat more than $999 million. 

philipat's picture

And, of course, Wall St also generally uses FORWARD earnings estimates. These estimates are prepared by "Sell-side" analysts with financial incentives not to be honest. Wall St forward earnings estimates are generally reduced by 10-25% during the year for which they were made in the prior year. It is better to use  Shiller's CAPE to measure earnings on a historical basis, adjusted for the business cycle.

Vampyroteuthis infernalis's picture

When you lie once, twice and etc. What's the difference over time? Fraud runs rampant!!

TheReplacement's picture

Is that what JCP is doing wrong?

I am Jobe's picture

“When plunder becomes a way of life for a group of men living together in society, they create for themselves in the course of time a legal system that authorizes it and a moral code that glorifies it”


 Frederic Bastiat

Oldwood's picture

Ultimately they can do as they wish. the corruption runs so deep that any that tried to play by what most normal people would consider fair and rational would be destroyed. For these corporation they must lie cheat or steal to get their number right, or else. Survival I understand. What I don't understand is why people will tolerate it. I guess because fundamentals don't matter in a casino. Everything is perception of what the other players hold in their hand. It seems that few ever have to show their hands.

in4mayshun's picture

ObamaCare may be where the "tolerance" ends. Most folks I talk to are choosing to face the penalties rather than be forced into medical tyranny. Once the civil disobedience begins, the tide will not easily be stemmed.

starfcker's picture

good point, in4. i don't know anybody who has even looked at the website. i talk current events with a bunch of people everyday, impact on their business, yes. buying in, no

Keyser's picture

Aside from the obvious reasons to dislike the ACA, the largest impact over time will be the reduction in quality and availability of health care services. 

HardlyZero's picture

25000 accountants (and honest books) laid off.

With creative finance who needs GAAP ?

The truth is only dragging down their get rid of the accounting part.

We are probably at Peak Ponzi.

TheFourthStooge-ing's picture


25000 accountants (and honest books) laid off.

Honesty in accounting is a red-flag indicator of an obsolete skill set. It's no wonder they were laid off.

With creative finance who needs GAAP ?

Employed accountants, that's who. GAAP (Grifting Accommodations, Abstractions, and Propaganda), in accordance with FASB (Fictional Accounting and Swindling Board), sets the standards for modern accounting theatrics.

WillyGroper's picture

I don't know which made me laff harder:

"GAAP (Grifting Accommodations, Abstractions, and Propaganda), in accordance with FASB (Fictional Accounting and Swindling Board), sets the standards for modern accounting theatrics.'

True Dat


"the nation’s accounting profession insisted were real, and that had been reported because the nation’s securities cops would have sent out the paddy wagons had they not been."

Wet Dream

topshelfstuff's picture

and this was done, though of course its been totally forgotten and never mentioned see signing statement;


The brief entry in the Federal Register, dated May 5, 2006, was opaque to the untrained eye. But the bureaucratic verbiage added up to this: President George W. Bush has bestowed on his intelligence czar, John D. Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from certain accounting and securities-disclosure obligations.

These include keeping accurate "books, records, and accounts" and maintaining "a system of internal accounting controls sufficient" to ensure the propriety of transactions and the preparation of financial statements in compliance with "generally accepted accounting principles."

Winston Churchill's picture

The only GAAP left is in my aquaculture pond.

Its all unicorns shitting skittles now.

S+P is a buy at 200, otherwise stay out of the casino.

TheFourthStooge-ing's picture


Its all unicorns shitting skittles now.

Those skittle shitting unicorns might be demonic legions.

According to the highest source:

In demonology, Gaap is a mighty Prince and Great President of Hell, commanding sixty-six legions of demons.

Exercise all due caution.

Keyser's picture

It's easy to sweep all the crap under the carpet when you have 2 sets of books. One set on the Cash basis and the other set that no one gets with all the accrued nastiness. 

czardas's picture

I am still surprised that there are those who doubt corporations are still making money.  Of course they are.  They are in the unique position of being able to pass along cost as price hikes - nothing illegal about that just as there is nothing sinister about the one-time writeoffs.  Perhaps disingenuous would be a better term.    Still, financial managers recognize shenanigans explaining why when some folks "beat the numbers" they drop like a rock - it's smoke and mirrors.

The real reason companies are still making profits (the driver of markets) is increased efficiency and soaring productivity due to technology.   More and more companies are building nearly automatic factories where light, AC and heat are rarely used.  Stores are turning over the sales job to fewer and fewer people as anyone who shopped during the holidays can attest.  I'm not sure where this increased efficiency will lead but so far, it's eliminated the largest expense for any business - payroll.  Who knows?  Amazon may even turn a profit someday.


Kayman's picture

1. So long as you are in the club you never have to make cash money.  The Fed will finance anything for its ilk.

2. In the trade-off between capital and labor, with the Fed dictating low rates, labor is going to be replaced by capital, since capital has become essentially costless- at least in the short run.  The evidence is provided in this article by David Stockman.  You can overpay for assets- look at Barrick Gold for wisdom- then right down your dumb moves, in turn wiping out all of your retained earnings (twice in 5 years) and yet remain in business.  No private company could ever do this.

Good article. 

VD's picture

buybacks r useful for innumerable line itemz...n tax purposes.....

SWRichmond's picture

Myths are good because that's all we have left.

Soul Glow's picture

Stockman gave a good interview on King World News last week.

Atomizer's picture

Cooking the books is the new market norm. No one can deny the global slowdown any longer.

Schacht Mat's picture

Globalisation has allowed this financial shell game to be further played across many reporting jurisdictions.  The amount of international jurisdictional financial kiting occuring to boost earnings based upon different reporting periods, (and then subsequently taking "one time" write off sto elimanate the tax burden) is another wrinkle in this racket.  Overvalued - many of those stocks are value less once debt based propping up of the consumer market is removed and the financial fog is lifted.

Common_Cents22's picture

large public companies are just like politiicians.    they say they are doing things in the best interest of (the people/shareholders) but actually that is a smokescreen as they are an old boy network scamming rigging things to enrich themselves, doing the bare minimum for voters/shareholders.     

I sold my company to a fortune 200 and witnessed it first hand.

It also has a lot to do with having to make your number on a quarterly basis.  they end up using accounting gimmicks to hit the number or manage expectations.   How can you really run a multibillion company on an every 90 day basis?

czardas's picture

Right and wrong.  I invest in start-ups and have found that the successful ones are hard-working, driven folks who don't sit on their ass all day and bitch.  They have ideas, implement them after much research, work like a slave for years then are rewarded handsomely as they should.   Most businesses - the overwhelming majority - strive to provide a quality product.  It's a point of pride.  I am on the board of one company that is on track to sell within three years for an incredible profit.  But this was only due to massive effort by the two owners -  work that few would even attempt.   

When companies produce a quality product, price it reasonably, have the customer in mind and play by the rules they don't need to worry about satisfying share holders or shady deals or cooking the books.  You are talking about corporations who act like central bankers - making money by buying and selling companies with little thought to the product.  

Peter Pan's picture

The same illusion is perpetrated on the masses with their own income.
Government should be reporting the income of workers ex direct and indirect taxation.

Colonel Klink's picture

When corporations and the market have become a rigged casino, why would anyone want to play that isn't part of the "insiders".

No thanks, I'll take all my marbles (stocks, bond, 401k, etc.) and walk away from the game.

logicalman's picture

But the underlings are required to be honest when it comes to tax time.

What a fucking sick joke the financial world has become.

buzzsaw99's picture

the smokescreen of recently reported big bank earnings is every bit as egregious as all that.

Stuck on Zero's picture

Screw earnings per share.  All that counts is divdends per share or returns to the investor.



mobydick's picture

Auditors & lawyers are the scum feeding this corporate gluttony

MarcusAurelius's picture

"The Fed can make it look like something it isn't, but it can't change what it is". - James Grant

I believe what everyone wants is simply the truth once again. The minority of intelligent people (like the ones here at Zero Hedge) know "real" from "smoke and mirrors". The problem with "smoke and mirrors" is the majority (the ones who could care less about Zero Hedge) fall for it every time. That is the reason for the great transfer of wealth effect that has been going on for the past forty years. 


Schacht Mat's picture

When I was involved in assessing the financial worth of companies, I went straight for the statement of cash flow.  Either the damn thing has money coming in, or money going out.  If you do something exraordinary, - OK - either show me the ROI on that activity (and that it is being achieved, and then take those earnings/savings out of your cash flow), or I expense it fully.  Not perfect, but better than baloney sheets and incrime statements.  I would also look at their market position, what is the future for that market in the geography served, and the quality of the people / culture.  Worked a tough beat and had a 5% failure rate (OK - some of the successes were just a squirt over B/E, but still ...)

q99x2's picture

The legalization of Enron accounting.

That should accelerate things a bit.

ItsDanger's picture

Its not so much about true P/E, but book value and present value of earnings to attain a valuation/  These market based P/Es of 17-18 are just BS.  Just look at AMZN. 

TheReplacement's picture

That would make a great tweet.

Spungo's picture

These articles are stupid because they don't apply to ANYONE. Who are these people that comb through the company's income statement and balance sheet but have no idea what they are looking for? Retail investors don't do that. Retail investors look at the PE reported by Google Finance or Yahoo Finance, which is the GAAP number. The people who dig into a company's numbers don't look at stupid, made up numbers that ignore huge expenses or use estimated future earnings. The professional investors are looking at things like free cash flow, ROE to price to book, net income, retained earnings, and various other things that are harder to manipulate. Right now (Jan 11), Google Finance says Alcoa has no PE ratio, meaning the company is losing money. Is someone saying their finance situation is actually WORSE than losing money? They're losing losing money but it looks like they're only losing money?

Mongoose's picture

I use the GFAP number. (Greater Fool Attraction Probability) It's a proprietary model of mine...

Back to killin' snakes


disabledvet's picture

isn't this the time of year for the rosy scenario stuff? seems like we're starting off on the wrong foot here...

Laughing Stock's picture

Stockman be droppin' bombs up in da hizzy!!!

Yancey Ward's picture

Wall Street's manipulation of corporate earnings is a special one-time, non-recurring case of analysis.  They promise that once this period is over, these kind of add-backs will cease to be meaningful.