December 2, 2021

Stop Worrying So Much About Non-GAAP Measures

A long time ago, in an accounting classroom far, far away, I heard one of my professors refer to EBITDA as “everything but the bad stuff,” implying that this non-GAAP metric could not and should not be trusted.

Then I started working and it soon became obvious that nearly everyone trusts EBITDA! The premise being that the D and the A are non-cash, so who cares and that the I and T really have nothing to do with the business, so who cares.

But these days EBITDA has morphed into something else, something called commonly known as adjusted EBITDA. Some might call it, “Earnings before whatever the hell we want.”

Adjustments allow companies to strip out such expenses as asset write-downs or the effects of foreign-currency moves that executives and many investors consider to be outside a company’s most fundamental operations. Companies also often omit results from newly opened and recently closed stores to better reflect ongoing operations

Scana Corp., a utility holding company, strips weather from its results to smooth out the effects of unusual warm and cold spells, for example. Underwear maker Hanesbrands Inc. adjusts its earnings for “actions” and the “tax effect on actions” that are described in footnotes and a series of tables at the end of its earnings release. Square Inc., the electronic-payments company that recently went public, reported adjusted revenue that omitted 14.5% of the company’s sales because they came from Starbucks Corp., which has announced plans to stop using Square’s services.

Restaurant chains like Potbelly Corp., burger joint Shake Shack Inc. and chicken-and-biscuits seller Bojangles Inc. exclude much of the costs of opening new stores. Telecom companies like AT&T and Sprint Corp. omit the multibillion-dollar depreciation bills that reflect the cost of upgrading their networks.

“There are those that use it as a way to take out nonrecurring type of items to help people understand how the business works,” said T.C. Robillard, vice president of investor relations at Hanesbrands. “Then there are companies out there like anything else in life that go out and misuse it.”

I think most accountants feel somewhat puritanical about GAAP because it’s drilled into us as students and auditors (tax people couldn't care less). But after a while we should be able to look at a non-GAAP metric and say, “Ha, that’s a good one. Oh, that’s what you’re reporting? Okay then, sure, just don't forget to include the real numbers.”

Matt Levine says that all this worry about non-GAAP metrics is a sign of “a troubling lack of faith in the efficiency of markets,” and that seems right. Companies pluck out the stuff they don’t like and maybe that’s misleading, but is it that misleading? In all of these cases, we know what the "bad stuff" is; it's not like companies are hiding them somewhere in one of Valeant's secret pharmacy relationships. If you don’t like the sound of adjusted EBITDA (as adjusted) or whatever, you can read the company's explanation and decide if it’s believable or not. From there, a person can look at GAAP info if they want to and further decide if that company is a big bowl of wrong. 

It's fine that the SEC and others will continue to express concerns about non-GAAP measures; they are highly visible, sound confusing and are kind of a joke. But the way I see it, for most people, non-GAAP metrics are sorta like the Kardashians. Sure they're everywhere, but you can ignore them if you really want to.

U.S. Corporations Increasingly Adjust to Mind the GAAP [WSJ] 

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