Why Are Adjusted Earnings Higher Than GAAP Earnings?

The headline says adjusted EPS of $1.60. Scroll down the same release and a smaller line says GAAP diluted EPS of $1.10. Both describe one hypothetical quarter at one company, and the fifty-cent gap between them is a list of decisions management made about what to count.

Where is the gap explained?

In a table, usually near the back of the release, titled something like “Reconciliation of GAAP to non-GAAP measures”. It starts with the GAAP figure and adds or subtracts each item until it reaches the adjusted one.

That table exists because of a rule. The SEC’s Regulation G says that when a public company discloses a non-GAAP financial measure, it has to present the most directly comparable GAAP measure alongside it and reconcile the two. The company picks the adjustments. It has to show them.

Real reconciliations often carry one more line, for the tax effect of the adjustments, which trims the total back a little. Look for it.

Footnotes under the table usually explain each line in a sentence or two. Read them, because the same label, “restructuring” or “acquisition-related costs”, can cover very different spending from one company to the next, and a line that sounds routine can hide a charge that has grown every year while the adjusted figure stayed smooth.

What gets added back, and why?

Each common exclusion comes with a reason the company will give. Some reasons hold up better than others.

Stock-based pay is the largest add-back at many companies. The stated reason is that no cash leaves. Yet employees are paid partly in shares, those shares dilute every existing holder, and a business that had to pay the same people the same amount in cash would report the expense without anyone suggesting it be left out of profit. The column on stock-based pay as a real cost makes that case in full.

Amortization of acquired intangibles is the gradual write-off of customer lists, patents and similar assets bought in an acquisition. The company paid for them. The cost happened. Excluding it can make an acquisitive company look more profitable than one that built the same assets internally and expensed the work as it went.

Restructuring charges cover layoffs, closed facilities and reorganizations. They are fair to strip out once. Less so when they show up every year.

Impairments are write-downs of an asset, often goodwill from an old deal, to a value below its book value. No cash moves that quarter. The money was spent earlier, when the deal closed.

One-time legal costs are settlements or large case expenses. Check the company’s history in court. Some businesses settle a case of one kind or another nearly every year.

When should the adjustments make you suspicious?

When the “one-time” items recur. A restructuring charge in eight quarters out of the last ten is part of how the company operates, and a reader who keeps adding it back is paying for a business that does not exist.

Watch the drift too. The gap may widen. The list of exclusions may grow. Or the company may redefine adjusted earnings from one year to the next. Each one moves the headline number without any change in the cash the business produces, and each is visible only if you read the reconciliation for several periods side by side, which takes a few minutes and is exactly the work the headline is designed to let you skip.

Is the adjusted figure useless, then?

No. It can help. A single large impairment can make GAAP earnings look terrible in a quarter when the business ran normally, and stripping it out shows the run rate. It also smooths comparisons across a big acquisition.

Read both. Start from GAAP, go through each adjustment, and decide which ones you accept. Keep the restructuring charge if it recurs. Add back the impairment if it truly was a single event. You may end up with your own figure somewhere between the two headlines, built from the company’s own reconciliation using your own judgment about which costs are part of running the business, and that figure is usually a better guide than either number the company chose to put first.

The earnings release lesson walks through the rest of a release, and the Ten-Q Very Much course covers the statements behind it. To test yourself on results like these, try the Below the Beat quiz.