Earlier today, one hour before consumer and medical products conglomerate Johnson & Johnson was set to report Q3 earnings, it unexpectedly announced that it would launch a $10 billion buyback, a move which we said would presage earnings that are "almost certain to be very bad."
A few minutes later this skepticism was confirmed when JNJ announced a huge miss in Q3 revenues of $17.1 billion, far below the $17.45 billion consensus estimate, and a whopping 7.4% down compared to the year earlier.
Of course, seen in this light the buyback announcement was merely there to cushion the blow from the weak Q3 earnings.
And yet, when looking at JNJ's EPS line, things were not nearly as bad, because despite a 7% slide in revenues and a whopping 40% collapse in pretax net income, somehow JNJ reported Q3 non-GAAP EPS of a solid $1.49, actually beating consensus of $1.45, and only 7% lower than a year ago.
Hardly terrible... until one looks at the detail and finds the same "oldest accounting gimmick in the book" which as we showed was used by both Coke and Intel last quarter: namely "adjusting" tax rates.
Here is what happened: a year ago, JNJ had a GAAP effective tax rate of 30.3%. This year? The number tumbled 38.9% to just 18.5%. Obviously applying a 40% lower tax rate to a 40% lower pretax number will result in almost a wash, and that is precisely what happened, because JNJ's non-GAAP, adjusted EPS dropped a very modest 7.5% from $1.61 to $1.49.
What happens if one appies the same tax rate to Q3 2015 as the company used a year ago?
Then again, to "offset" the bitter taste in the public's mouth from a 38% plunge in earnings, JNJ would have to buyback so much stock it would be downgraded to Junk overnight. Which will still happen, but not quite yet: for now investors in the S&P continue to willingly play along with these non-GAAP, charge addback, tax rate games played by company management teams. It is only after the money runs out that everyone will finally wake up to what has been going on before everyone's eye but it will be too late.