by Rachel Annis
  Equity Analyst, Gradient Analytics LLC (a Sabrient Systems company)

In any given quarter for almost every publicly traded company, there is often a swirling vortex of signals as to the firm’s long-term health and future opportunities. Within this conflux of signals, there are two that often cause investor stress and confusion when they contradict each other: GAAP versus non-GAAP earnings.

The simple rubric that often comes to mind is that GAAP earnings are the more conservative figure for the firm [as these accounting standards are closely monitored and controlled by a governing board, the Financial Accounting Standards Board (FASB)], while its non-GAAP earnings are the more optimistic view (after being heavily tweaked and adjusted by management). However, this assumption does not always hold true. Often, a firm’s non-GAAP results more accurately represent its historical earnings power.

But it’s not clear-cut. As the global economy struggles to emerge from the severe and diverse impacts of the pandemic, corporate financial reports have been littered with a variety of non-GAAP adjustments that need to be deciphered and analyzed, particularly as investors transition from a speculative “recovery rally” mindset (that has bid up valuations) to a greater focus on fundamental earnings quality.

Gradient Analytics specializes in forensic accounting research and consulting to discern weak versus strong earnings quality, which has proven valuable for both short idea generation and vetting of long candidates, as we have discussed in a previous article. So, with the current flood of adjusted earnings, we felt it would be a good time for some examples to illustrate that not all earnings adjustments are created equal, and although investors must be judicious in deciding when and how they use non-GAAP results, they often may be better served by focusing on non-GAAP.  Read on....