Even the SEC woke up. But what will the media do?
All 30 companies in the Dow Jones Industrial Average have now reported earnings for the first quarter. As required, all of them reported these earnings under GAAP, the thicket of Generally Accepted Accounting Principles that is supposed to help investors get some insights into the financial condition of the company.
But 19 of these 30 companies also reported “adjusted” earnings that they skillfully draped over their GAAP earnings, and now it all looks just so much prettier.
GAAP gives companies a lot of leeway to beautify their results. But in these challenging days of ours, it’s still too hard to make earnings look good enough. So companies, in collaboration with Wall Street analysts and the media, use their own principles that they make up as needed. And they’re certainly needed.
In Q1, according to FactSet, the companies in the DJIA that “adjusted” their earnings inflated them on average by 28.9% over their earnings under GAAP.
And the inflation in “adjusted” earnings is picking up. Last year, only 16 of the 30 companies in the DJIA resorted to this beautification strategy. And they inflated earnings by only 19.7% on average.
By “adjusting” earnings, the companies purposefully inflate growth of earnings and of earnings per share – crucial metrics that Wall Street bandies about in an attempt to justify sky-high stock prices.
In Q1, these 19 companies in the DJIA that “adjusted” their earnings showed an earnings growth of 5.7% on average, up from 4.3% under GAAP. And another tidbit: adjusted median EPS growth (half are over, half under) was 3.9%. But under GAAP, median EPS growth was just 0.7%.
Here are the five companies in the DJIA that inflated their earnings the most:
- GE by 200%, from $0.02 a share under GAAP to a whopping $0.06 a share under its own principles.
- Merck & Co. by 122%, from $0.40 a share to $0.89 a share.
- Caterpillar (it really needs a boost as its revenues have been getting hammered for years) by 46%, from $0.46 a share to $0.67 a share.
- Pfizer by 37%, from $0.49 a share to $0.67 a share.
- Coca-Cola Company by 32%, from $0.34 a share to $0.45 a share.
These are large companies. They tend not to go entirely crazy, unlike outfits with relatively recent IPOs that have never made any money and need every trick and device to keep their stock prices up.
Twitter for example. It lost money every quarter. In Q1, it lost $80 million under GAAP. But once Twitter got through adjusting that loss, it was a non-GAAP profit of $103 million.
That $183-million swing, obtained by adjusting the numbers, is proportionately huge, given that revenues were only $595 million. The adjustment had taken EPS from a loss of -$0.12 a share to a profit of $0.15 a share. A miracle!
Tesla is one of the few companies that managed to inflate even its revenues – and by a big chunk! Its Q1 “non-GAAP” revenues were $1.6 billion, up “over 45%” year-over-year, as it said in its press release. But its GAAP revenues were only $1.15 billion, and revenue growth was half of what Tesla pretended with its “adjusted” numbers.
In other words, Tesla inflated its revenues by 39%! That takes some doing!
Tesla’s net loss jumped by 83% to $282.3 million, or $2.13 a share. Shareholders are immune to these losses as Tesla has lost money during its entire decade of existence. Then it “adjusted” this loss down to $75 million, or -$0.57 a share, cutting its loss by 65%!
All this data is publicly available. Anyone reading beyond the hype is going to see it. The media even reports some GAAP numbers, usually hidden in the middle of the sixth paragraph or so, after they thoroughly beat you up with “adjusted” data and “analysts’ expectations.”
But no one wants to see it. Instead, everyone wants to believe the sweet fairy tale spun by Wall Street and Corporate America. We’ve come to call this phenomenon, “Consensual Hallucination.”
Even the SEC is getting worried. For months, they’ve been admonishing Corporate America and Wall Street about the prominence of these “adjusted” numbers in earnings presentations and in press releases. Then the media take it from there, putting these “adjusted” numbers into the headline, which is all many people read. FactSet and others that aggregate and mine Wall Street data use these “adjusted” numbers in their reports and charts. These “adjusted” numbers are everywhere, drowning out any sense of reality.
In March, SEC Chair Mary Jo White came out to Silicon Valley, where non-GAAP has become an innovative art, and said that the SEC may consider new regulations to “rein in” how these non-GAAP numbers are used. Numerous other SEC folks have since made the rounds.
On Wednesday, Mark Kronforst, chief accountant of the SEC’s corporation-finance division, told an advisory group to the Public Company Accounting Oversight Board that there would be “an uptick” in comment letters the SEC sends to companies about the use of non-GAAP numbers. “We are sending a message and we are going to continue talking about it,” he said.
This comes on top of the new guidance the SEC issued this week, attempting to clarify when a company gives too much prominence to non-GAAP metrics. The SEC long has had some requirements, but they’re “not working,” Kronforst said. “I think this next quarter will be a great opportunity for companies to self-correct.”
Even if companies perform the miracle and “self-correct,” we doubt that the media and Wall Street analysts will “self-correct.” They’re the main perpetrators in the propagation of these fairy tales. If they’d wanted to, they could have stopped long ago featuring these fairy tales in their headlines and reports, but no way, that might have tripped up stock prices.
So how does this reality look for Corporate America. The Federal Reserve released its delinquency data for all commercial banks in the first quarter – very sobering data. Read… Business Loan Delinquencies Spike to Lehman Moment Level
Enjoy reading WOLF STREET and want to support it? Using ad blockers – I totally get why – but want to support the site? You can donate “beer money.” I appreciate it immensely. Click on the beer mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.