Do Non-GAAP Earnings Adjustments Deliver Comparability Benefits?

Filling in the GAAPs in Individual Analystss Street Earnings Forecasts

“…He finds that analysts often exclude non-cash earnings items, and concludes that analysts make exclusions because of the difference in the relative weights investors place on the different types of underlying earnings components. 3 In addition, Liu and Gao [2016] conclude that Street earnings are more comparable across firms and over time than are GAAP earnings, likely due to the removal of nonrecurring items as well as recurring items subject to measurement error. These studies suggest that analysts do not merely mimic management in making exclusions and that the exclusions are motivated both by analysts' 3 Whipple [2015] associates analysts' forecasted earnings exclusions with each of stock compensation expense, amortization expense, and gains/losses in a hand-collected sample.…”

An inside-out perspective to valuation

“…Bhattacharya et al (2003) and Brown and Sivakumar (2003) provide evidence that street operating earnings are more persistent than GAAP operating income and that market participants perceive them as more relevant. In a similar vein, Liu and Gao (2016) show that street earnings better reflect core and continuing operations following analysts' expertise and professional judgment. Frankel and Lee (1998) use analysts' earnings forecasts to estimate a firm's fundamental value and document a high correlation with both contemporaneous and future stock returns.…”

“…Specifically, street earnings may further improve multiple valuation via the identification of more comparable peers. Liu and Gao (2016) empirically show that, following adjustments by analysts and I/B/E/S, street earnings are significantly more comparable than GAAP earnings. This enhanced comparability among firms should then facilitate benchmarking, thereby improving multiple valuation (Young and Zeng, 2015).…”

“…First, street earnings are more informative as they remove accounting distortions from the financial statements (Black et al, 2017a). For example, while GAAP earnings contain non-recurring items, analysts typically exclude such items because they are usually not part of firms' normal operating activities (Liu and Gao, 2016). Street earnings may hence show a more accurate picture of the target firm's true performance, and consequently serve as a better basis for multiple valuation.…”

“…We argue that adjusted accounting numbers -so-called street earnings -form a better basis for valuation, as accounting distortions are filtered out and these numbers therefore better reflect true economic performance (Liu and Gao, 2016). Especially for valuation methods that rely on the identification of comparable peer firms, street earnings have the potential to improve valuation (Frankel and Roychodhury, 2005).…”