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Tag Archives: SEC

How Investors Should Navigate the Non-GAAP Earnings Confusion

16th June, 2016 · Adam Schwab, CFA, CFP · Leave a comment
Adam Schwab, CFA, CFP

An Introduction and Three Guiding Principles

There has been a recent surge in the controversy surrounding non-GAAP earnings. While the debate continues on the proper use of non-GAAP metrics, investors can’t expect outside help and need to take control of their own understanding and interpretation of non-GAAP adjustments. Investors can’t rely on “guidance” from companies or regulators.

The problems run deeper than the GAAP vs. non-GAAP debate. The actual problem is investor’s lack of commitment to a thorough, fundamental understanding of the company. Without adequate understanding, investors will never be able to tell non-GAAP truth from fiction.  There is never a hard and fast set of rules to determine the validity of GAAP exceptions. Like any set of standards, there are exceptions and situations that don’t fit the model. The extreme doubters of GAAP or non-GAAP miss the point: no system is perfect. It’s the investor’s responsibility to determine the best representation of economic reality. Blind devotion to SEC guidance, FASB standards, or company management is a dangerous path.

This series of articles will help guide investors into asking the right questions involving non-GAAP metrics. This advice cannot replace actual analysis, but will give investors a better framework for thinking about these issues.

3 Rules to Remember

  1. Always reconcile each adjustment using the GAAP to non-GAAP reconciliation

Regardless of a company’s adjustments, investors should always reconcile to GAAP earnings. This figure, required by the SEC, allows investors to see a clean breakdown of non-GAAP adjustments. Unfortunately, that’s the easy part. The hard part is understanding what items are legitimate and which are not. Analyze every line item on an individual basis to determine its validity. One or two adjustments account for most of the deviations from GAAP. Unfortunately, there are no clear cut answers on which expenses are legitimate and which are egregious. Materiality depends on the company and industry dynamics. The only way to know is to dive deep into the business and financial statements.

  1. Pull up and compare reconciliations for the past 5 years

Don’t limit your analysis to the current year. Compare what “recurring”, non-recurring expenses have been consistent over many years. Repeated appearance is clear evidence that these charges are recurring in nature, even as management argues “one-off” or too volatile/unpredictable. In fact, a quick glance at successive reconciliations should show no yearly correlations between line items. Also, understand that the absence of repeated charges doesn’t mean one-time charges are legitimate. Evaluate every adjustment on its own merit.

  1. Match the reconciliation to the business model

Serial acquirers should not have their acquisition-related charges excluded. Acquisitions are part of their strategy and the associated expenses are legitimate and recurring. Major problems develop when analysts and management teams guide to high top and bottom line growth without the necessary acquisition spending to support that growth. It’s unfortunate that overconfident/aggressive companies and investors permit this mismatch to make valuation, free cash flow, and EPS more impressive. Some quick investor math on the implied ROICs would show an unsustainable level of ROIC into the future.

Look for Part 2 of this series next week on Freezing Assets.

Adam Schwab, CFA, CPA is a partner and portfolio manager at Elgethun Capital Management. Contact Adam at aschwab@elgethuncapital.com. Visit adamdschwab.com for more investing articles and podcasts.            

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Posted in Hot Topic Commentary, Local Charterholders | Tags: Adam Schwab, CFA, CPA, Elgethun Capital Management, non-GAAP earnings, SEC |

What’s an SEC Review and Why Should You Care?

15th June, 2015 · John P. Gavin, CFA · Leave a comment

The first in our “SEC Basics” series, this video introduces you to

  • The SEC’s Division of Corporation Finance
  • What Goes into a Review
  • SEC Comment Letters

Let me know what you think or other topics you’d like videos on.

John P. Gavin, CFA
Founder and CEO
Probes Reporter, LLC
feedback@probesreporter.com
Or click here to use our online Contact Us form

 

About Us | Probes Reporter, LLC

Probes Reporter™ is an independent publisher of investment research.  We gather data and records on public companies, analyze them, and publish our findings.  Our focus is in the area of public company interactions with the Securities and Exchange Commission (SEC).

Probes Reporter, based in Minnesota, was founded by John P. Gavin, CFA.  Mr. Gavin is is a holder of the right to use the Chartered Financial Analyst (link is external)® designation.  He has over 30 years of experience as a professional investor & entrepreneur.

Probes Reporter’s origins date back to 2000, when Mr. Gavin started SEC Insight/Disclosure Insight. Disclosure Insight™ is now a trademark and research product line belonging to and produced by Probes Reporter.

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Posted in Hot Topic Commentary, Local Charterholders | Tags: Comment Letters, Division of Corporate Finance, SEC, SEC Review, Video |

Ask the Ethicist: Discussing Work at Home

24th October, 2014 · CFAMNEB · Leave a comment

I live with a significant other, and we are not engaged or married. We talk about our days at work openly. I strongly trust my significant other, but being in the securities industry I am terrified of inadvertent information leaks and others we know trading on the information. That person agreed verbally never to talk about my activities outside our home. I want to keep myself covered, but I also want to be open to my significant other about my life’s work. What can I do?


Dear terrified investment professional afraid to discuss work at home:

You raise some good points but have nothing to fear. You are smart and it is prudent to agree with your significant other that he should not discuss anything about your work with third parties. This understanding should also include not tipping or trading on any such information. You, like most people, naturally want to talk at home about what happens at work since we spend so much time at work. The need to share with our significant other often conflicts with employment and compliance policies that prohibit disclosure of proprietary information, and securities law and fiduciary duty restrictions that prohibit disclosure of work-related activities.

This issue got a lot of attention recently when the SEC Enforcement Division brought an insider trading case against Filip Szymik, whose roommate worked as an analyst at William Ackman’s Pershing Square Management. Szymik learned from his roommate that Ackman was going to make a public presentation on why Herbalife, a publicly traded company, is a ponzi scheme.  Szymik had told his roommate that he would not trade on the information. Despite the understanding, Szymik told a friend named Peixoto about the upcoming presentation. Peixoto bought put options that traded in the money when Herbalife stock tanked after Ackman’s presentation.  Peixoto made only about $47,000.  The SEC charged Szymik with insider trading for tipping material nonpublic information to Peixoto who traded on the information and made a profit.  This case demonstrates the risks of trading and tipping material nonpublic information, and shows that the SEC will bring cases even against relatively small players to deter misconduct.

You have nothing to worry about from the SEC if you do not disclose material nonpublic information that your significant other could trade on or tip to another who trades.  What constitutes material nonpublic information is often a difficult interpretative question. Because Ackman is a prominent activist investor and his views and positions will affect the market, his views on Herbalife were clearly material.  Materiality is usually defined as what a reasonable investor would deem to significantly alter the total mix of information available or what a reasonable investor would deem significant in making an investment decision given the total mix of information available.  The SEC has not defined materiality, it has been defined in court cases.  Usually, but not always you know if you have material nonpublic information.  If you learn about key events before they are public such as a merger, tender offer, earnings information, loss or acquisition of key contract or business relationship and the like, you probably have material nonpublic information.  If you are trading for a client that is acquiring or disposing of a large position, you probably have non-public information.

If you need to talk about your work at home, try to talk about work in a general way without revealing nonpublic information to avoid breaching duties to clients, violating employer’s policies or securities laws.

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Posted in Ask the Ethicist, Ethics | Tags: ask the ethicist, discussing work at home, SEC, securities |

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