Question

Many industries have Non-GAAP presentations specific to that industry. Why must an analyst be careful when using this information?

Answer 1

There are instances in which GAAP reporting fails to accurately portray the operations of a business. Companies are allowed to display their own accounting figures, as long as they are disclosed as non-GAAP and provide reconciliation between the adjusted and regular results. Non-GAAP figures usually exclude irregular or noncash expenses, such as those related to acquisitions, restructuring or one-time balance sheet adjustments. This smooths out high earnings volatility that can result from temporary conditions, providing a clearer picture of the ongoing business. Forward-looking statements are important because valuations are largely based on anticipated cash flows. However, non-GAAP figures are developed by the reporting company, so they may be subject to situations in which the incentives of shareholders and corporate management are not aligned.

Studies have suggested that the exclusion of stock-based compensation from earnings results materially reduces the predictive power of analyst forecasts, so non-GAAP figures that merely adjust for equity compensation are less likely to provide actionable data. However, non-GAAP results from responsible firms grant investors unparalleled insight into the methodology employed by management teams as they analyze their own companies and plan future operations.