Pro Forma Earnings: Not the Whole Story
fool.com
In a time when a disappointing earnings number can cause a company's stock to tumble, more and more companies are focusing on "pro forma" earnings to back out some distorting factors. This is supposed to give investors a clearer view of a company's operations, but since there is no regulatory guidance for pro forma earnings, companies have increasingly used them to make their earnings look better. An expense may be non-cash or one-time in nature, yet still have significance.
Pro forma statements have no rules
But those who blindly accept pro forma earnings statements are simply aping what the companies want them to hear. This isn't to say companies are being dishonest with pro forma earnings: In general the numbers are not being manipulated, as pro forma statements don't constitute fraud. But when reading non-GAAP earnings, being serially skeptical may end up saving you big money.
When companies are allowed to determine just what constitutes a "one-time expense," you've got to be awfully careful not to accept them at face value. Some companies, for example, make a habit of taking "one-time" charges, writing off inventory instead of selling it at discount, and taking the resultant hit on the balance sheet. If this is a recurring tactic, it's a warning sign that the company may be trying to mask underperformance and boost earnings.
Investors should be mindful of pro forma figures not only when tracking one company's performance, but when comparing it to competitors using multiples of earnings or other measures. Since companies may use pro forma figures differently -- or not at all -- it's important to ensure that the information used in such an analysis creates a true "apples to apples" comparison.
The Securities and Exchange Commission (SEC) does not have any authority over company press releases unless outright fraud has been committed -- if, for example, a company reported sales that never actually happened. Still, it has voiced concerns about companies that seem to shove all their bad news into the non-pro forma category in a play to make results appear better. (Amazingly, I've yet to see a pro forma statement come out from a company that shows it in a worse light than GAAP would have.) |
