Hi Newbie and welcome to the board. Here’s what adjusted or non-GAAP earnings are. This is straight from the Knowledgebase, which is at the top of the right hand ribbon descending each post page on this board:
## Investment Primer…
Adjusted earnings are another important term. The accountants preparing the quarterly reports have to follow what are called GAAP rules, which stands for “generally accepted accounting principles.” The problem is that some of the rules distort the true picture of how the company is doing, and others are just stupid.
Therefore, many, many companies give non-GAAP or “adjusted” results alongside the GAAP results. If the company had a large one-time expense or windfall, a legal expense or suit settlement, for example, they would remove these from the calculations to get adjusted results.
Also stock-based compensation, or option grants must be counted as an expense by GAAP rules, although there is no cash expense, and in spite of the fact that they are already counted by an increase in the diluted shares. Almost all companies remove this double counting expense in figuring adjusted earnings.
I ignore GAAP results almost entirely, and almost always use adjusted results, which usually make more sense and are more useful.
## Adjusted (Non-GAAP) vs. GAAP Earnings
I use adjusted results because they tell you what the real company is doing. I pay no attention to GAAP earnings and only look at non-GAAP or adjusted earnings. I know this bothers some people, but it’s what I do. I feel that GAAP earnings ridiculously distort the picture. (Consider company X that has a big tax benefit this quarter and reports huge GAAP earnings, and then next year they pay normal taxes and looking at GAAP it appears as if their earnings have tanked, just for a trivial example. Or company Y that has outstanding warrants. If their stock price goes up, GAAP rules makes their apparent GAAP earnings go down due to repricing of warrants. Just nonsense. I especially remove stock-based compensation as an expense).
I don’t like excessive stock compensation either, but you have to remember that at most small technology companies, that is most of executive compensation as the companies don’t have much money. It also allies the insider’s interests with ours if they have options that are only valuable if the price goes up.
I ignore the stock-based compensation because it is already accounted for in diluted shares. More shares reduces earnings per share. Taking it as an expense too double counts it, which is why almost every company that I know of subtracts out the stock based compensation non-cash expense when they figure adjusted earnings or “real earnings.”
In the earnings press releases, management almost always gives a reconciliation between adjusted and GAAP figures and how they got there. You can see exactly what they leave in and take out so you aren’t taking it on blind trust. If I have confidence in management, I just use the adjusted earnings they give. If I start messing around and adding and subtracting things I won’t remember next time what I did and why, and also the earnings won’t be comparable with past and future earnings. On the rare occasions that I do eliminate something (sometimes companies show big swings up and down in foreign exchange gains and losses, for instance), I make a big note in red in my notes about the quarterly results so I’ll remember to eliminate the same thing next time. This perhaps sounds overly trusting, but what I’m aiming for is seeing how the company has been functioning over time, and accepting management’s adjusted earnings usually works for me. After all, they are trying to evaluate the same thing.
It’s important that you realize just how insane that GAAP rule is. Let’s consider what would happen if some terrible news came out about PSIX during the next quarter. For example, if a big new engine had a bunch of defects, or a new competing product showed up which was taking lots of their customers, their revenue was dropping like a rock, and their price really crashed (for good reason!).
GAAP rules for repricing the warrants would mean that the company would show huge (imaginary) INCREASES in GAAP earnings for the quarter!!! And this is from a system that is supposed to be giving the public a clearer idea about what is really happening at the company!
(For those who wonder what their rational is, it’s: stock price down = obligation from warrants reduced = more GAAP “profit”)
By the way, analyst earning estimates are almost always adjusted earnings too, as far as I know. Also the companies’ disclaimers almost always specify that they use adjusted earnings for their own internal evaluations of how the company is doing. They often give GAAP results as a formality, and then base their entire discussion of results on adjusted results.
For those who think that GAAP are the only valid earnings, and that Non-GAAP are just “cheating,” here are the latest PSIX results.
GAAP earnings: 68 cents
Adjusted earnings: 39 cents
WHOA! Adjusted just about half of GAAP? It’s supposed to be the other way around! How can that be? Because, as usual, GAAP has a lot of nonsense in it:
GAAP is up because the stock price was down so they had to reevaluate the “liability” of the warrants downward due to the lower stock price. This gave more GAAP “earnings”. (Note that if the stock price had been up, repricing of the warrants for more liability would give lower earnings. If you think that makes sense, well…)
In addition, GAAP income includes a non-cash gain resulting from a decrease in the estimated fair value of the “contingent consideration liability” recorded in connection with an acquisition. This also gave more GAAP earnings.
Now if you think GAAP gives a better idea of how the actual business did in the quarter, be my guest. As I said, it’s nonsense to me.