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Barron’s gave us these 6 as examples of stock based compensation: “When stocks are falling, however, there’s only one kind of earnings that pass muster—those based on generally accepted accounting principles, or GAAP.”
Take earnings. In a bull market, especially one fueled by the Federal Reserve pumping money into the economy, it doesn’t usually matter what kind of numbers a company reports. If the company “beats,” the stock usually rises.
When stocks are falling, however, there’s only one kind of earnings that pass muster—those based on generally accepted accounting principles, or GAAP. “For the past few years, you could have ignored accounting, financial statements, or anything else and it didn’t matter,” says Wolfe Research Chief Investment Strategist Chris Senyek. “Now, given that Fed liquidity is being drained and interest rates are increasing, it’s back to fundamentals: balance sheets, cash flow, and reading annual reports.”
Large gaps between operating and GAAP earnings could be a sign that a company isn’t doing nearly as well as it says it is. Those gaps can be driven by factors ranging from acquisitions, restructuring charges, and the use of stock-based compensation such as restricted stock units and options granted to employees and executives in lieu of cash. The latter, in particular, can skew earnings in a way that can result in huge differences between GAAP and adjusted numbers.