Tags: GAAP | Earnings | Market | Overvalued

Michael Carr: GAAP Earnings Show Market Almost 50 Percent Overvalued

Michael Carr: GAAP Earnings Show Market Almost 50 Percent Overvalued
(Dollar Photo Club)

By    |   Tuesday, 08 March 2016 05:55 AM


Companies like investors to ignore generally accepted accounting principles (GAAP). That way management can fill an earnings announcement with excuses known as “one-time charges.”

Following GAAP means not making excuses. Reporting adjusted earnings allows companies to ignore anything that lowers earnings, like dollar fluctuations or stock-based compensation.

Accountants know currency changes affect earnings every quarter and developed rules to report that impact. When reporting earnings last quarter, many managers claimed they would have done better if we exclude the effect of the strong dollar. Their statements often seemed to be deliberately misleading.

IBM, for example, reported that the strong dollar reduced revenue by $7 billion and earnings were $300 million lower in the fourth quarter because of currency changes. Closely reading the company’s statement shows that IBM mixed apples and oranges. They a large effect on revenue for the year and earnings for the quarter. Sound accounting principles requires not mixing reporting periods.

Next quarter management might want us to look at GAAP earnings. When a weak dollar boosts earnings, we generally don’t see similar headlines saying investors should ignore the effect of currency translation. Management is more than happy to take credit for that result and boost their bonuses which are usually in the form of share-based compensation they also claim investors should ignore.

As a whole, companies in the S&P 500 want investors to believe they made about $100 a share in 2015. Under GAAP rules the results would be significantly lower at about $88 a share. Using GAAP earnings, the market is trading with a price-to-earnings (P/E) ratio of 23, about 48 percent higher than average.

Stocks are undervalued only if we believe management and ignore expenses the company actually incurs. GAAP isn’t perfect but it provides standardized rules. Adjusted earnings are somehow always favorable to the company and should be viewed as advertising by smart investors.

Michael Carr, CMT, is a subadviser to a mutual fund family and a chartered market technician. To read more Michael Carr, CLICK HERE NOW.

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Companies like investors to ignore generally accepted accounting principles (GAAP). That way management can fill an earnings announcement with excuses known as "one-time charges."
GAAP, Earnings, Market, Overvalued
334
2016-55-08
Tuesday, 08 March 2016 05:55 AM
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