New Way Public Companies Are Misleading Investors

It’s frustrating each morning to hear the anchors on the financial news channels say key stock indices are poised to open higher when you know the fundamentals are tormented…but it goes on day after day, week after week, month after month. 

Dear reader, if there is one old adage I’d like to stress, it is this one by famed economist John Maynard Keynes: “Markets can remain irrational longer than you can remain solvent.”

 Irrationality eventually ends, and when market participants are faced with reality, they panic and run for the exit. We have seen this phenomenon occur every single time key stock indices have gotten overvalued. In my life, I saw it in the years 1987, 2000, and 2007, and I believe we are seeing it again today. 

Keep in mind that the further the markets soar on speculation, the harder they fall; the higher key stock indices go, the uglier the market sell-off that follows. 

In today’s market, it’s not just stock advisors who are being irrational. The companies on key stock indices are doing their part as well to give the illusion that all is well, that their high stock prices are justified. 

In 2012 and 2013, we saw public companies in key stock indices use “financial engineering” to make their corporate earnings per share look better. In specific, public companies undertook record stock buybacks in both years. Then we saw them cutting their expenses via workforce reductions. Mind you, they are still buying back their shares and cost-cutting to push up per-share earnings because revenue growth just isn’t there. 

But now they have found another way to justify their high stock prices! 

“Non-GAAP” per-share income is being reported by an increasing number of public companies. 

Let me explain… 

GAAP stands for generally accepted accounting principles. It is the standard way of reporting corporate earnings across different industries. Non-GAAP corporate earnings exclude factors like one-time charges or special costs that companies say are not “regular.” 

Below, I present a chart of Alcoa Inc.’s (NYSE/AA) corporate earnings, divided by GAAP and non-GAAP. 

ALCOA’S CORPORATE EARNINGS PER SHARE
GAAP VS. NON-GAAP

Data source: Alcoa Inc. web site, last accessed April 24, 2014 

Since the second quarter of 2013, the company has incurred a cumulative loss of $2.44 per share when looking at GAAP earnings. Alcoa flat-out lost money over the past 12 months. But when we look at non-GAAP earnings per share…funny how Alcoa gives the impression it is making money every month. And it’s even funnier to note that Alcoa seems to be posting one-time expenses every quarter that need to be added back to give a “true reflection” of how the company is doing. Hogwash! 

Its stock price? You guessed right. Alcoa’s stock price increased by 76% in this period. 

What you see here is just one example. There are numerous companies on key stock indices that are getting away with “sugarcoating” their earnings and apparently getting the market’s support. 

Dear reader, key stock indices are treading in a very dangerous territory. Irrationality is significant these days. And I’m one of the few bears left that see the rally in key stock indices as a sucker’s rally. Many of my colleagues who were bears have thrown in the towel and turned bullish. I won’t give in and abandon reality! I continue to believe key stock indices are severely overbought and that this picture will not end well. 

This article New Way Public Companies Are Misleading Investors was originally posted at Profit Confidential