Yep, US companies tried to hide a ton of bad news from investors last year

US companies tried to hide a lot of bad news from investors in 2015.

When companies report earnings they give investors a series of numbers. The most basic measure of earnings per share is profit divided by diluted shares. This figure is most often referred to as GAAP — or Generally Accepted Accounting Principles — earnings.

But a growing trend has been reporting an “adjusted,” or non-GAAP figure, which includes the company’s best estimate of things that came up during a quarter or year that, in the company’s judgment, were charges outside the normal course of business.

As a result, non-GAAP earnings tend to be higher.

Earlier this week Yahoo Finance’s Sam Ro wrote about the possibility of an “illusion” of corporate earnings propping up stocks. That is: do corporate earnings look better because of the growing trend in reporting non-GAAP earnings that hide charges which may not actually be all that special?

In a note on Friday, FactSet’s John Butters looked at this “illusion” by examining the growing spread between these figures.

And whether you think non-GAAP or GAAP earnings represent the “true” profitability of US corporates, it is very clear things looked a whole lot better on a non-GAAP basis last year.

Looking at the 30 companies in the Dow Jones Industrial Average, Butters found that 20 companies reported non-GAAP earnings with these results, on average, coming in 30.7% higher than their GAAP earnings in 2015. In the 2014, this spread was 11.8%.

So said another way, US companies tried to get investors to ignore a whole bunch of bad news last year.

March 11 COTD 2016

On the one hand, this suggests that companies basically fudged their numbers last year. On the other hand, companies could argue that extraordinary events in currency or commodity markets were “one-time” items that should be excluded from results.

Legendary value investor Ben Graham wrote in his famous book “The Intelligent Investor” that it’s hard to really ever nail down what a company did or did not make in a given quarter or year.

So most of this GAAP against non-GAAP debate comes down to philosophical as much as mathematical views on what companies and businesses are worth or are not worth.

Maybe companies are deceiving investors, or maybe companies are simply doing their best in a dynamic business world to represent what they think their business is worth, which investors are entitled to — perhaps even encouraged to — disagree with: the first rule of investing, of course, is that you must do your own homework.

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