There is a reason why, when looking at S&P 500 earnings, we only care about GAAP numbers: the reason is that any non-GAAP "data" has become as meaningless as "adjusted EBITDA" - a goalseeked, procyclical placeholder which gives zero indication of the true financial state of the company and is merely a propaganda tool used by management and its preferred investment bank to raise capital or its stock price (and hence, equity-linked executive compensation) to naive investors.
A recent example of this was in December, when we found that "Surprise, GAAP S&P500 EPS Set To Decline 1.3% In 2014", suggesting that all that euphoria about corporate profitability growth was only due to addbacks and accounting adjustments of "one-time, non-recurring" expenses... such as $178 billion in recurring, non one-time legal charges for the Libor, FX, Gold and everything else-rigging crime syndicate better known in common vernacular simply as "banks".
Well, we are delighted that finally others too are starting to look at the real gimmicks used and abused by corporations everywhere to "report" better than expected numbers. Enter the WSJ, which came, saw at Non-GAAP "numbers", and was horrified to find the costs companies are "stripping out of those measures to enable themselves to show profits seem to be getting ever more eyebrow-raising."
The scam is so simple it would have continued to slide under the radar for years to come if someone didn't finally dare to call the emperor naked: "As The Wall Street Journal reported Thursday, 40 companies that had initial public offerings in 2014 reported losses under standard accounting rules. Yet those companies showed profits using their own tailor-made measures, according to consulting firm Audit Analytics – the highest level of such companies in at least the past several years.
For anyone who has had to "adjust" EBITDA even once, none of this is news, and as the WSJ also notes, "companies have long used such metrics, often omitting costs like interest, taxes and employee stock compensation, and thus boosting their results. But now, more companies are taking out more types of costs that would seem to belong in earnings calculations. During the past year, some companies going public have excluded from their nonstandard measures costs like regulatory fines, “rebranding” expenses, pension expenses, costs for establishing new manufacturing sources, fees paid to the board of directors, severance costs, executive bonuses and management-recruitment costs."
In fact it may soon be time to call uber non-GAAP EPS simply enough as... revenue.
“Whatever it takes to get that (customized earnings) number up to support a valuation, is what they’ll back out,” said Anthony Catanach, a Villanova University accounting professor.
To be sure, companies are still required to prominently disclose their results under traditional accounting rules, a good example being our recent comparison of Tesla's laughable parallel income statements, one GAAP one non-GAAP, for both EPS and revenue (yes non-GAAP revenue):
But as the WSJ adds, companies contend that the additional non-standard “non-GAAP” measures they provide – those that don’t follow generally accepted accounting principles, the official set of U.S. accounting rules – give investors a clearer picture of their ongoing performance. They say it’s proper to strip out what would seem to be ordinary costs if they’re non-cash or one-time expenses that distort the official GAAP numbers.
Actually the reason is far simpler: companies know they are lying, and investors know they are being lied to, but at the end of the day it simply a case of Mutual Assured Destruction if anyone dares pull their head out of the sand, because the simple admissions that everything is a lie threatens to bring the entire house of cards crashing down!
And while we have done so many times over the years, we are surprised that the WSJ dares to stir the hornets' nest. Some of its case studies:
Adeptus Health Inc.ADPT -0.75%, an emergency medical services provider that went public in June, stripped out $2.4 million in management bonuses to help get from a $15.8 million loss in the first nine months of 2014 to an $18 million profit under “adjusted Ebitda,” or earnings before interest, taxes, depreciation and amortization, modified further to exclude other costs like the bonuses, $6.1 million in preopening costs for new facilities, and $156,000 in “management recruiting expenses.”
An Adeptus spokesperson said the company uses non-GAAP metrics “to provide investors with a more complete understanding of our underlying business performance,” and that it was “consistent” with many other companies’ practices.
LendingClub Corp.LC +1.60%, a peer-to-peer lender which went public in December, uses a non-GAAP performance measure called “contribution margin” intended to measure the profitability of its loans. But the earnings figure the company uses to compute that margin strips out general and administrative expenses – ordinary corporate overhead costs, in other words.
If those expenses had not been excluded, LendingClub’s contribution margin for the first nine months of 2014 would have been negative, instead of the positive 44.1% it reported. LendingClub declined to comment.
So what happens if one ignores the lies that non-GAAP brings and focuses on real, accounting-based numbers? For the answer we repost our article from late November when the S&P was at 2070, and when the S&P500 EPS was well higher than where it will be in 2015 as a result of the collapse in Energy EPS:
Goldman may have been right that there will be no more multiple expansion in 2015, but there sure was quite a bit overnight thanks to the latest verbal and actual central bank interventions by the ECB and the PBOC. And as a result, the biggest beneficiary is the S&P500, which is set to open just around 2070, or about 30 points shy of Goldman's 2015 S&P500 year-end target.
And for those who still care about such things, the chart below shows that fundamentally, the S&P is now trading at 17.5x non-GAAP LTM EPS, and, drumroll, 19.2X GAAP PE!
At the current daily pace of increase, David Tepper can finally pop that champagne bottle early next week, because his long-held dream of a 20X P/E (GAAP that is) will have finally materialized (he may have to wait until Christmas for 20x non-GAAP).
And all it took was the coordinated intervention of every single developed and developing central bank.
At this moment, net of the consensus plunge in Energy earnings, the S&P is precisely at 20x GAAP P/E. Which, according to Charlie Evans is "catastrophically" cheap.