The Difference Between GAAP And Non-GAAP Q3 Earnings For The Dow Jones Was 25%
As of today, 95% of the companies in the S&P 500 have reported earnings for Q3 2016. 72% of the companies have reported earnings above the mean estimate and 55%of S&P 500 companies have reported sales above the mean estimate. More importantly, however, according to FactSet in Q3 the earnings recession officially ended after five consecutive quarters of EPS declines: for Q3 2016, the blended earnings growth rate for the S&P 500 is 3.0%. The third quarter marks the first time the index has seen year-over-year growth in earnings since Q1 2015 (0.5%).
That’s the official version. The unofficial one is that of this 3% increase in EPS, half comes from buybacks, or a reduction in the number of shares outstanding, which according to Deutsche Bank contributed 1.6% to earnings growth in the third quarter. As the chart below shows, this has been a recurring theme for the S&P, where buybacks have “added” between 1% and 2% to EPS “growth” every quarter going back at least to the start of 2012.
And then there was the very acute distinction between GAAP and non-GAAP, one of our favorite topics which we have covered going as far back as 2010, and more recently in February of this year.
In another report by FactSet, we find that as of today, all of the companies in the Dow Jones Industrial Average have reported EPS for Q3 2016. Factset then asks three questions:
- What percentage of these companies reported non-GAAP EPS for Q3 2016?
- What was the average difference and median difference between non-GAAP EPS and GAAP EPS for companies in the DJIA for Q3 2016?
- How did these differences compare to last year?
For Q3 2016, 21 of the 30 companies in the DJIA (or 70%) reported non-GAAP EPS in addition to GAAP EPS for the third quarter. Of these 21 companies, 16 reported non-GAAP EPS that was higher than GAAP EPS.
The average difference between non-GAAP EPS and GAAP EPS for all 21 companies was 181.1%, while the median difference between non-GAAP EPS and GAAP EPS for all 21 companies was 10.4%.
The average difference between non-GAAP EPS and GAAP EPS for the DJIA was unusually large because of DuPont. For Q3 2016, DuPont reported non-GAAP EPS of $0.34 and reported GAAP EPS of $0.01. Thus, the percentage difference between non-GAAP EPS and GAAP EPS for DuPont for Q3 was 3300%. Excluding DuPont, the average difference between non-GAAP EPS and GAAP EPS for the remaining 20 DJIA companies was 24.7%.
How does this compare to the third quarter in 2015? Back in Q3 2015, 19 of the 30 companies in the DJIA (or 63%) reported non-GAAP EPS in addition to GAAP EPS for the quarter. Of these 19 companies, 16 reported non-GAAP EPS that was higher than GAAP EPS. The average difference between non-GAAP EPS and GAAP EPS for all 19 companies was 17.1%.
This means that the GAAP to Non-GAAP difference (excluding outliers), continues to grow, or as FactSet puts it, the average difference between non-GAAP EPS and GAAP EPS for the Dow 30 was larger in Q3 2016 relative to Q3 2015. However, the median difference between non-GAAP EPS and GAAP EPS for the Dow 30 in Q3 2016 was nearly equal to the median difference in Q3 2015. While more DJIA companies reported non-GAAP EPS in Q3 2016 (21) compared to Q3 2015 (19), the same number of DJIA companies (16) reported non-GAAP EPS that exceeded GAAP EPS in both quarters.
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Putting all this together, the distinction for year-over-year earnings growth for GAAP vs non-GAAP Dow Jones earnings is simple: non-GAAP Dow Jones earnings rose 10.8%, while GAAP EPS declined 3.7%:
Companies in the DJIA reported higher average and median year-over-year growth in non-GAAP EPS compared to GAAP EPS for Q3 2016. For the 21 companies in the DJIA that reported non-GAAP EPS for Q3 2016, the average non-GAAP EPS growth rate was 10.8%, while the median non-GAAP EPS growth rate was 5.1%. For these same 21 companies, the average GAAP EPS growth rate for Q3 2016 was -3.7%, while the median GAAP EPS growth rate for Q3 2016 was -1.2%.
As Deutsche Bank writes in a note on Friday afternoon, “be mindful of the gap between GAAP and non-GAAP EPS and net margins“
The German bank explains that over the past two years, the wider than usual spread between GAAP and non GAAP is from asset write-downs at Energy and Materials companies. Outside those sectors, the spread at ~87% excluding huge discontinued operations and one-time gains at Health Care, modestly below normal. The overall spread bottomed at 68% in 4Q15 and subsequently improved to ~81% in the past two quarters and ~84% QTD.
In addition to write-downs, stock option expense (SOE) is often excluded by new Tech, bio Tech and some tech oriented consumer stocks. 42 S&P companies exclude SOE from their non-GAAP EPS, and that SOE would have had $1.07/sh impact to S&P EPS. Also, when M&A activity is strong there are often deal and integrations costs that are excluded. This is mostly at Tech and Health Care. Pension charges are sometimes excluded. This was a big item in 4Q14 and will likely be so again in 4Q16.
Some additional details from DB:
The chart below shows a long-term chart showing the divergence between the S&P500’s LTM EPS on a GAAP vs non-GAAP basis…
… and finally, here is the implied LTM P/E multiple if using Friday’s S&P closing price: it amounts to 18.7x for non-GAAP earnings, and 23.4x for GAAP.