While we mostly pay attention to things such as year-over-year growth rates, earnings surprise, and the percentage of companies beating or missing expectations, we take a step back to look at the underlying reported data by companies and whether they report results on a Non-GAAP or GAAP basis. You may be surprised at some of the findings in this note.
Using the excel add-in provided by Refinitiv Workspace for Analysts and Portfolio Managers, we look at two data points found in the I/B/E/S datatype which include a) EPS actual value (what sell-side analysts use to value a company – Non-GAAP (pro-forma) or GAAP), and b) EPS reported actual value (statutory reported actual, known as GAAP). The universe used for this analysis is the Russell 1000 index.
As of March 1st, 924 constituents have reported 2022 Q4 earnings, of which 661 constituents have reported EPS results on a Non-GAAP basis compared to 263 constituents reporting on a GAAP basis. In percentage terms, this translates to 71.5% reporting on a Non-GAAP basis and 28.5% reporting on a GAAP basis.
At a sector level, Information Technology has the highest percentage of constituents (91.4%) that report EPS on a Non-GAAP basis, followed by Basic Materials (91.1%), Consumer Staples (84.4%) and Health Care (80.2%).
Real Estate has the highest percentage of constituents (85.1%) that report EPS on a GAAP basis, followed by Communication Services (52.2%), Utilities (44.7%), and Consumer Discretionary (32.7%), as shown in Exhibit 1.
Exhibit 1: Russell 1000 2022 Q4 EPS Actuals Type – Non-GAAP vs. GAAP
Is there really a difference between Non-GAAP and GAAP?
Given that three fourths of the Russell 1000 reported results this quarter on a Non-GAAP basis, we look further to assess whether earnings are over inflated or under inflated compared to GAAP. [Spoiler alert: earnings are inflated on a Non-GAAP basis.]
If we aggregate 2022 Q4 EPS for every constituent that has reported (924 constituents, which is a blend of GAAP and Non-GAAP, but mostly Non-GAAP as outlined above), blended aggregate earnings are approximately $497.2 billion. If we conduct the same calculation, except we apply the GAAP EPS for every constituent in this subset, aggregate earnings declines to $372.6 billion. This means that Non-GAAP earnings were 33.4% higher compared to GAAP earnings (using all companies that have reported to date).
For comparison, if we aggregate 2022 Q4 EPS for only constituents that have reported on a Non-GAAP basis (661 constituents) the percentage difference is even more pronounced. For this subset, Non-GAAP aggregate earnings are approximately $366.3 billion. If we conduct the same calculation, except we apply the GAAP EPS to every constituent in this subset, aggregate earnings declines to $241.7 billion. This means that Non-GAAP earnings were 51.5% higher compared to GAAP earnings (using only companies that have reported on a Non-GAAP basis to date).
From a breadth perspective, of the 661 constituents that reported EPS on a Non-GAAP basis this quarter, 525 constituents have reported Non-GAAP earnings which are higher than GAAP earnings. In percentage terms, this equals 79.4% of constituents which highlights the upward impact of one-time adjustments.
Information Technology had the highest percentage of constituents report Non-GAAP earnings above GAAP earnings (91.3%), followed by Health Care (86.5%), Basic Materials (82.4%), and Communication Services (81.8%).
How do you know if a company reports Non-GAAP vs. GAAP?
There are a few ways to ascertain this in Refinitiv Workspace. The easiest way to see this is looking at the StarMine Earnings Quality Model (EQ).
EQ measures the reliability and sustainability of the sources of a company’s earnings. Globally, it consists of three major components: Accruals – those transactions for which no cash has exchanged hands (a less reliable source of earnings); Cash Flow – transactions backed by free cash flow (the sustainable source of earnings); Operating Efficiency – the return on net operating assets; and for U.S. companies, Exclusions – the degree to which pro-forma, or reported earnings differs from GAAP.
We focus on the latter and show how a user can look at the Exclusions component for a single U.S. security as shown in Exhibit 2. [Note: Exclusions Component is only available for U.S. securities]
Exhibit 2: StarMine EQ Model
Source: Refinitiv Workspace
When clicking on the chart icon under the Exclusions header, a graph will pop-up and show a quarterly time-series of Non-GAAP vs. GAAP EPS. Bars are coloured Grey, Red, or Green. A red bar appears when reported earnings are above GAAP earnings – if this happens every quarter, it is due to one-time adjustments being included/excluded which causes pro-forma earnings to be higher than GAAP earnings. The bar will appear red as this type of reporting is unsustainable in the long-term.
Conversely, if companies report earnings that are below GAAP earnings, a green bar will appear as this shows conservative behaviour by the company which is an indicator of longer-term sustainability.
As shown in Exhibit 3, when a company reports Earnings that is the same as GAAP earnings, we see a grey coloured bar. We also include another picture below which shows red bars, to highlight the difference (we refrain from calling out individual names).
Exhibit 3: Exclusions Component of Earnings Quality Model
Source: Refinitiv Workspace
Conclusion
Looking at the Russell 1000, we note that almost three fourths of the index reported results on a Non-GAAP basis. Information Technology has the highest percentage of constituents that report EPS on a Non-GAAP basis, followed by Basic Materials, Consumer Staples, and Health Care (80.2%).
We also found that Non-GAAP earnings were roughly 33.4% higher compared to GAAP earnings, indicating the positive upward impact of one-time adjustments found in pro-forma earnings.
Users of Refinitiv Workspace for Analysts and Portfolio Managers can rely on the StarMine Earnings Quality Model to determine the sustainability of corporate earnings.
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