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Trust, But Verify
Posted by: Dr. Paul Price (IP Logged)
Date: June 23, 2013 01:16PM
The Same, Yet Different.
It used to be simple. Companies reported earnings in accordance with GAAP (Generally Accepted Accounting Principles). Media sources published the news.
In recent years company managements and sell-side analysts have taken to adjusting GAAP data higher. Those better-sounding profit numbers are called Non-GAAP.
The non-standard measures of financial performance are far looser than GAAP numbers. Many times it is only these inflated results that are widely circulated by the press.
Financial website Investopedia said it this way…
"Many companies report non-GAAP earnings in addition to the required GAAP earnings stating that the alternate figure more accurately reflects their performance. Some common examples of non-GAAP earnings measures are cash earnings, operating earnings, EBITDA (earnings before interest, taxes, depreciation and amortization) and pro-forma income.”
Companies would rather have analysts focus on higher ‘adjusted’ EPS in order to make their stock valuations look cheaper. Restating EPS to carve out employee stock option expenses obscure true compensation levels, including those of company officers.
Differences in reported data can arise from many sources. Other common adjustments come from merger-related expenses, revenue recognition decisions, plus any or all non-recurring items and even the most appropriate number of shares outstanding to be used in calculating EPS.
Managements must always disclose GAAP earnings. Often, however, they are buried in the footnotes of SEC reports and earnings call transcripts. Companies would rather have analysts focus on higher ‘adjusted’ EPS in order to make their stock valuations look cheaper.
On-line financial sites don’t always disclose when they are not using GAAP figures. This can make a huge difference in the reported P/E that various research services carry for the same stock.
Pharmacy benefits management firm Express Scripts (ESRX) provides a prime example. Its shares closed at $62.98 on Monday, June 17, 2013. Here are the ‘Analyst Estimates’ sections for ESRX as shown on that date from Yahoo Finance, MSN Money and Value Line.
Yahoo used Non-GAAP estimates in showing 2013-2014 projections of $4.30 and $4.93 respectively. They did not mention or footnote that these were not GAAP estimates. Investors using those numbers came up with reasonably low P/E multiples of 14.7x and 12.8x for this year and next.
MSN Money Central showed an almost identical set of estimates. Once again the current year and 2014 multiples look quite low for a high-quality, conservatively financed growth company.
Check out ESRX in Value Line and you see a very different set of estimates. Value Line’s research used GAAP accounting in coming up with 2013 and 2014 expectations of $2.70 and $3.30. Based on those numbers this year’s P/E is 23.3x and the 2014 multiple would be 19.1x.
Value Line noted that Express Scripts’ management has said publicly that they see $2.80 for 2013 including any additional amortization charges from the 2012 purchase of Medco Health Solutions. It is mainly these non-cash charges that created the large discrepancy in reported EPS.
How would a typical investor know that? Which figures are correct? Does two-out-of-three count? Consulting MSN money would break the tie with estimates based on non-GAAP, again without mentioning that fact. Taking the time to read official company reports, with all their footnotes, will make you a better informed investor.
Deciding if a stock is reasonably priced means comparing apples to apples. Don’t get caught thinking a valuation is low by viewing adjusted EPS the comparing those figures against previously reported GAAP data.
You would expect that well-regarded sources of financial data could be relied upon for accuracy. As always, it is safer to trust… but verify.
Express Scripts is a large personal holding for me. Whichever way you choose to calculate its earnings the company appears to offer good growth prospects.
Disclosure: Long ESRX shares
A wide variety of easy-to-understand educational articles is available here
Details of my Value Portfolio can be seen here [marketshadows.com]
Stocks Discussed: ESRX,
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