Shift from non-GAAP
bottom lines could be good for stock prices
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[August 19, 2017]
By Noel Randewich
SAN FRANCISCO (Reuters) - Investors worried
about lofty stock-market valuations may take comfort in signs that
companies in the benchmark S&P 500 index are padding their bottomlines
less than they have in previous years.
Recent changes to accounting standards and a crackdown last year by the
Securities Exchange Commission are encouraging many companies to be more
cautious about reporting metrics that do not adhere to Generally
Accepted Accounting Principles (GAAP).
The difference between S&P 500 companies' GAAP net incomes and the
adjusted versions of net income that they play up to Wall Street is
expected to significantly shrink in 2017 for a second year, after
hitting a high in 2015, according to a Thomson Reuters analysis.
Such a decline may be good news for investors worried that stock prices
have risen too far.
"The closer reported earnings are to GAAP, the more confident I'd be
that investors are getting a fair characterization," said Jack Ablin,
chief investment officer at BMO Private Bank in Chicago.
On their income statements, companies often exclude "extraordinary"
items, like charges associated with layoffs that they believe give
investors an unclear picture of their performance. Those adjustments
tend to make their profits appear stronger.
After an 8-percent rise in 2017, the S&P 500 is trading at 17.8 times
expected earnings, a level many investors consider expensive and
increases the risk of a market selloff. But the expected earnings in
that valuation are adjusted, not GAAP.
To the extent that companies use non-GAAP accounting less this year than
in recent years, investors may feel more comfortable paying higher
valuations for their stocks.
"You're getting more conservative in your earnings approach rather than
more aggressive," said Phil Blancato, head of Ladenburg Thalmann Asset
Management in New York. "That's exactly why I don't think current PEs
are very expensive."
Following new accounting standards covering the taxation of stock-based
compensation, Google parent company Alphabet Inc. <GOOGL.O> stopped
excluding stock-based compensation from its costs in the first quarter.
Facebook Inc. <FB.O> said it would no longer emphasize non-GAAP
expenses, income, tax rate or earnings per share.
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Traders work on the floor of the New York Stock Exchange (NYSE) in
New York, U.S., August 17, 2017. REUTERS/Brendan McDermid
Responding to a new standard on revenue recognition, Microsoft Corp. <MSFT.O>
recently said it will switch to GAAP revenue reporting.
Analysts expect S&P 500 corporations in 2017 to report a total of about $1.06
trillion in GAAP net income, according to Thomson Reuters data. But allowing for
non-GAAP adjustments made by many companies and analysts, total net income is
expected to reach around $1.17 trillion.
Still, that 10-percent difference between GAAP net income and the net income
companies and many investors focus on is much smaller than in 2015, when the
difference was 33 percent, the largest gap since at least 2009. Last year, the
difference shrank to 22 percent. (http://tmsnrt.rs/2fRRogA)
Thomson Reuters analyzed 494 S&P 500 companies and adjusted some of their fiscal
years to reflect calendar years. In cases where companies and analysts focused
on GAAP, that number was counted as adjusted net income.
Adding to pressure on U.S. chief financial officers, the SEC last year sent
comment letters to corporations questioning their accounting methods. It warned
companies not to produce misleading quarterly reports using larger fonts and
bolded type to emphasize non-GAAP metrics.
"The SEC was upset about how non-GAAP was being used, and I think people have
tried to listen to that. Nobody wants an SEC comment letter," said Takis
Makridis, chief executive of Equity Methods, which advises companies on equity
Silicon Valley's technology giants have additional reasons to start emphasizing
"The biggest companies who, earlier in their evolution needed to show numbers
that put them in a more favorable light, no longer need that advantage," said
Pivotal Research analyst Brian Wieser. "It raises greater contrast with
companies that are just emerging."
(Reporting by Noel Randewich; Editing by Bernadette Baum)
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