For years we had been covering the steady divergence between plain vanilla GAAP EPS and their "as adjusted" non-GAAP comparable, a number which accountants generally frown upon and which investors love as it always shows a far rosier earnings (and cash flow) picture than is in reality. Lately, this divergence rose to a level not seen since the financial crisis when as we showed recently, non-GAAP addbacks accounted for a quarter of the entire Q4 non-GAAP EPS of the S&P500.
Then, with the usual several year delay, the mainstream press figured out that an ever greater amount of corporate "earnings" is totally bogus. This is what the AP's Bernard Candon wrote last month in a reported titled "Experts worry that 'phony numbers' are misleading investors [6]":
"as the stock market climbs ever higher, professional investors are warning that companies are presenting misleading versions of their results that ignore a wide variety of normal costs of running a business to make it seem like they're doing better than they really are."
The financial analysts who are supposed to fight corporate spin are often playing along. Instead of challenging the companies, they're largely passing along the rosy numbers in reports recommending stocks to investors.
"Companies are tilting the results," says fund manager Tom Brown of Second Curve Capital, "and the analysts are buying it."
An analysis of results from 500 major companies by The Associated Press, based on data provided by S&P Capital IQ, a research firm, found that the gap between the "adjusted" profits that analysts cite and bottom-line earnings figures that companies are legally obliged to report, or net income, has widened dramatically over the past five years.
At one of every five companies, these "adjusted" profits were higher than net income by 50 percent or more. Many more companies are in that category now than there were five years ago. And some companies that seem profitable on an adjusted basis are actually losing money.
So some are finally paying attention.
Others, however, those few who keep piling into tech stocks where the non-GAAP euphoria is worst, are openly refusing to accept a reality in which companies that are reliant on advertising dollars are expected to grow massively over the next decade, even as an economic recession, one which the Fed's rate hike will guarantee, is sure to crush advertising spending and clobber cash flows of the bulk of social media stocks.
Meanwhile, this is what the numbers say: according to the latest GAAP EPS data from Q1, in which a quarter of companies have already reported, GAAP EPS will coming in just shy of 23, a decline of 9.2% from a year ago, following the brutal 17.2% collapse in GAAP EPS in Q4, a quarter in which non-GAAP addbacks made the adjusted EPS number be a 4.7% increase!
But what is worse, is that those who ignore non-GAAP adjustments, are about to observe the worst quarter since 2012: the 22.98 in Q1 EPS will match the lowest quarterly EPS print of the S&P500 since Q3 of 2012!
[7]
And keep in mind all of these disappointing non-GAAP and GAAP EPS take full advantage of over half a trillion in corporate stock buybacks in the past year, drastically reducing the "per share" number in the EPS calculation.
But how is this possible when everyone is saying earnings continue to rise? Simple: the bullish case is revealed in the non-GAAP addbacks, which are highlighted in red in the chart below:
[8]
Showing just the addbacks (with the final Q1 number certain to rise above the 7.4 EPS benefit in Q4 when the remaining 75% of companies report earnings) we can see that the latest 2 quarters will have the greatest amount of "one-time" non-GAAP addbacks since the crisis.
[9]
Finally putting it all together, here is the LTM GAAP and non-GAAP EPS, and the resultant P/E ratios for the S&P on a 2015 forward basis (using Deutsche Bank's optimistic growth forecasts for the rest of 2015 which have Q4 2015 GAAP EPS projected to grow 23% from lastt Q4).
[10]
As of this moment, with the S&P500 at 2130, the S&P 500 is trading at 18.1x forward (non-GAAP) PE based on 2015P EPS of 118, and an unprecedented 20.3x GAAP PE if one uses the far more realistic 105 GAAP EPS.
Which one is real? It depends on whether readers believe that 18 points of S&P 500 "earnings" in the last 12 months (just under 20%) which comes from "one-time items, addbacks and other charges" are a credible "adjustment" to make to the earnings of the world's biggest stock market. But think of it this way: 18 S&P point in the last 12 months are from addbacks, "one-time items" and non-GAAP charges. Applying an 18x multiple, this means that 325 S&P500 points is purely due to accounting gimmickry, ignoring all the other stuff about margins, revenues, buybacks, commodities, China and all the "other" topics pundits waste their time debating every day.
