Corporate America has been playing a lot of games with earnings.
In the first quarter of this year, 19 of the 30 corporate giants that make up the Dow Jones Industrial Average reported two earnings numbers: GAAP and non-GAAP.
GAAP — short for earnings that follow Generally Accepted Accounting Principles — are considered the “raw” numbers that include things many managements ought to be seen-through by investors: charges related to divestitures, acquisitions, foreign-currency adjustments, and so on.
Non-GAAP figures (also known as “adjusted” earnings) leave some of these things out.
And in the first quarter of 2016, non-GAAP earnings were 28.9% higher than GAAP earnings, on average, among companies that reported both, according to FactSet Research.
In the same quarter last year non-GAAP earnings were 19.7% higher than GAAP earnings, on average.
That this spread increased, of course, shouldn’t come as a total surprise to investors or the market.
And while the recent behaviour of corporate America has made headlines, the ambiguity inherent in any set of quarterly results is not a new phenomenon.
Writing in his classic investing book “The Intelligent Investor,” Ben Graham, who taught Warren Buffett among others at Columbia Business School, looked at how companies’ earnings per share figures can be portrayed in a variety of ways.
Graham wrote that, “The more seriously investors take the per-share earnings figures as published, the more necessary it is for them to be on their guard against accounting factors of one kind and another that may impair the true comparability of the numbers.”
And so whether earnings are called GAAP or non-GAAP, taking just one number from a single quarter is a recipe for overthinking how one evaluates a company. Recall that Graham’s axiom — like Buffett’s — is to buy great companies at good prices.
If your assessment is correct, then no matter how a company presents their most recent quarterly performance given enough time one thing will be true: the business will be worth more.
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