In an article titled “Earnings: Not as Advertised” in today’s Wall Street Journal print edition, Justin Lahart reports:
FactSet estimates companies in the S&P 500 earned 0.4% more per share in 2015 than the year before. That marks the weakest growth since 2009. But that is based on the so-called pro forma figures, results provided by companies that exclude certain items such as restructuring charges or stock-based compensation.
Look to results reported under generally accepted accounting principles [GAAP] and S&P earnings per share fell by 12.7%, according to S&P Dow Jones Indices. That is the sharpest decline since the financial-crisis year of 2008. Plus, reported earnings were 25% lower than pro forma figures–the widest difference since 2008, when companies took record charges.
The implication: Even after a brutal start to 2016, stocks still may be more expensive than they seem… The result could be that share prices have even further to fall before they entice true value investors.
The article (which is not publicly available online) concludes:
Overall S&P 500 earnings under GAAP came to $787 billion last year, S&P Dow Jones Indices estimates. That is $256 billion less than the pro forma estimate of $1.04 trillion.
For investors taking a clear-eyed view, a bad year looks even worse.
So what’s this saying? Here’s an analogy. Say you have a family dairy farm, and you sold 0.4% more gallons of milk in 2015 than in 2014. You could report that your pro forma earnings increased by 0.4% in 2015. But, say that the barn where you store all your farm equipment (tractors, milking machines, etc.) was struck by lightning and destroyed, and you didn’t have insurance to protect against that. You’re going to have to replace all of that equipment in order to stay in business, so that’s a very big loss! Under GAAP, you’d have to include the loss of all that equipment, so your stated earnings would be 0.4% minus the replacement cost of all that equipment. Meanwhile, you could still state a pro forma earnings increase of 0.4% for 2015, because the likelihood of another lightning strike that destroys that barn next year is minimal (plus, now you bought insurance!).
The point: the GAAP earnings much better reflect the actual financial condition of these companies. When Chesapeake Energy reports (as it did yesterday) a pro forma loss of $329 million (just 2% of its $14.9 billion GAAP loss) because it adjusted for items “typically excluded by security analysts in their earnings estimates” and the main “excluded” item is the loss Chesapeake incurred because of the plummet in oil prices — that’s very misleading. Sure, oil prices don’t drop by 50% year after year after year, but the reality is that the drop that’s already occurred means Chesapeake may be in serious financial trouble, like many other companies in the oil industry.
A 12.7% decline in S&P 500 2015 GAAP earnings is a serious problem. Our economy may not be doing anywhere near as well as some people claim.