The Same, Yet Different.
It used to be simple. Companies reported earnings in accordance with GAAP (Generally
Accepted Accounting Principles). Media sources published the news.
In recent years company managements and sell-side analysts have taken to adjusting GAAP
data higher. Those better sounding profit numbers are called Non-GAAP.
The non-standard measures of financial performance are far looser than GAAP numbers. Many
times it is only these inflated results that are widely circulated by the press.
Financial website Investopedia said it this way…
"Many companies report non-GAAP earnings in addition to the required GAAP earnings stating
that the alternate figure more accurately reflects their performance. Some common examples
of non-GAAP earnings measures are cash earnings, operating earnings, EBITDA (earnings before
interest, taxes, depreciation and amortization) and pro-forma income.”
Companies would rather have analysts focus on higher ‘adjusted’ EPS in order to make their
stock valuations look cheaper. Restating EPS to carve out employee stock option expenses
obscure true compensation levels, including those of company officers.
Differences in reported data can arise from many sources. Other common adjustments come
from merger-related expenses, revenue recognition decisions, any or all non-recurring items
and even the most appropriate number of shares outstanding to be used in calculating EPS.
Managements must always disclose GAAP earnings. Often, however, they are buried in the
footnotes of SEC reports and earnings call transcripts. Companies would rather have analysts
focus on higher ‘adjusted’ EPS in order to make their stock valuations look cheaper.
On-line financial sites don’t always disclose when they are not using GAAP figures. This can
make a huge difference in the reported P/E that various research services carry for the same
stock.
Pharmacy benefits management firm Express Scripts (ESRX) provides a prime example. Its
shares closed at $62.98 on Monday, June 17, 2013. Here are the ‘Analyst Estimates’ sections for
ESRX as shown on that date from Yahoo Finance, MSN Money and Value Line.
Yahoo used Non-GAAP estimates in showing 2013-2014 projections of $4.30 and $4.93
respectively. They did not mention or footnote that these were not GAAP estimates. Investors
using those numbers came up with reasonably low P/E multiples of 14.7x and 12.8x for this year
and next.
MSN Money Central showed an almost identical set of estimates. Once again the current year
and 2014 multiples look quite low for a high-quality, conservatively financed growth company.
Check out ESRX in Value Line and you see a very different set of estimates. Value Line’s research
used GAAP accounting in coming up with 2013 and 2014 expectations of $2.70 and
$3.30. Based on those numbers this year’s P/E is 23.3x and the 2014 multiple would be 19.1x.
Value Line noted that Express Scripts’ management has said publicly that they see $2.80 for
2013 including any additional amortization charges from the 2012 purchase of Medco Health
Solutions. It is mainly these non-cash charges that created the large discrepancy in reported
EPS.
How would a typical investor know that? Which figures are correct? Does two-out-of-three
count? Consulting MSN money would break the tie with estimates based on non-GAAP, again
without mentioning that fact. Taking the time to read official company reports, with all their
footnotes, will make you a better informed investor.
Deciding if a stock is reasonably priced means comparing apples to apples. Don’t get caught
thinking a valuation is low by viewing adjusted figures against previously reported GAAP data.
You would expect that well-regarded sources of financial data could be relied upon for
accuracy. As always, it is safer to trust… but verify.
Express Scripts is a large personal holding for me. Whichever way you choose to calculate its
earnings the company appears to offer good growth prospects.
Disclosure:
Long ESRX shares