Friday, August 23, 2013

A Question for Mary Jo: What Is Your Definition of Earnings?


“What is your definition of the dollar?”
—Rep. Ron Paul to Federal Reserve Chairman Ben Bernanke, March 2, 2011

 We have a simple question for the commissioner of the SEC, and it’s a takeoff on the question famously asked of Ben Bernanke by the take-no-prisoners crackpot otherwise known as Ron Paul.
 Our question for Mary Jo White is this: “What is your definition of Earnings?”
 We ask it on the heels of the recent Target Corporation quarterly earnings call, in which the company led each discussion of so-called “earnings” with the phrase “Adjusted EPS” rather than GAAP EPS.
 Here’s how they started their script:
 Target's second-quarter financial results reflect strong US profit performance in spite of soft traffic and sales…. As a result, we delivered second-quarter adjusted EPS of $1.19, at the high end of our expectation going into the quarter. Our GAAP EPS of $0.95 was in the middle of our expected range, reflecting higher than expected dilution of $0.21 from our Canadian segment. As we monitor the economy and consumer sentiment, we continue to see a mix of signals in which emerging optimism is balanced with continuing challenges.
And here’s how they concluded before taking questions:
 For the full year, we've become incrementally more cautious in our US sales outlook, given our own recent results and those of our competitors. … Even with our more tempered sales expectation we believe full-year adjusted EPS will remain in the $4.70 to $4.90 range we provided previously, although our expectation has moved to the low end of that range. We expect full-year GAAP EPS will be approximately $0.95 lower than adjusted EPS reflecting $0.82 of dilution from the Canadian segment combined with a net $0.13 of dilution from the credit card portfolio sale and associated debt repurchase.
 By way of background, Target recently entered the Canadian market after buying a bunch of store leases from Hudson’s Bay two years ago.  The newly opened Canadian Target stores are losing money at the moment.  Quite a bit of money—something like half a billion dollars in their first year. 
 Target management, not wanting to spook the easily-spookable analyst community on Wall Street, simply subtracts those losses, along with some other stuff, from its GAAP EPS (readers may recall that “GAAP” accounting means, to be clear, earnings in accordance with Generally Accepted Accounting Principles) to create something it calls “Adjusted EPS.”
 And Wall Street’s Finest dutifully report what Target gives them.
 In fact, in my inbox following the call were half a dozen Wall Street analyst reports using the “Adjusted EPS” figures in their earnings—and Price/Earnings—tables.
 Not the GAAP EPS figures.
 Readers will recall that it was the bastardization of GAAP earnings into non-GAAP, made-up, adjusted earnings that fooled Hewlett-Packard’s investors into thinking the company was doing better than it was doing for so many years.
 In its defense, of course, Target will argue that investors want to see the “underlying” earnings from the company’s core business, and that certainly has an appealing sense of logic to it.
 However, the company’s investment in Canada is not a one-off.  It is not a science experiment.   It is not, yet, a “discontinued operation.”
 It is, in fact, part of the company’s core business.  
 Indeed, hundreds of public companies across America right now are investing in things that may or may not pay off, yet they do not exclude the expense of those things in “Adjusted earnings.”
 Worse, Target includes expected earnings from Canada in the out-years of their financial forecasts, as they bragged on their call:
 We’re still very confident in our Canadian strategy, stores and team and continue to believe the segment will generate $0.80 or more of EPS in 2017.
 So, as with Hewlett-Packardwhich routinely excluded the bad stuff from acquisitions (goodwill amortization and restructuring costs) in its “Adjusted” earnings while including the good stuff (sales, gross profit and operating income, such as it was) from acquisitions— we have a retailer that wants Wall Street to exclude the bad stuff (upfront costs of entering Canada) and include the good stuff (future earnings from Canada).
 That sort of freeform, highly elastic notion of “Adjusted Earnings” ended badly for HP and the Wall Street analysts who bought into it, not to mention the poor shareholders who couldn’t fathom why HP’s stock kept going down even though the “Adjusted” earnings looked so good.
 Now, we’re not suggesting Target is ever going to look like HP. 
 It’s just that your grey-haired editor can’t help but recall when Target’s nemesis, Wal-Mart, opened its first stores in Canada back in 1994, using the same technique of buying existing stores (in Wal-Mart’s case they were old Woolco stores) and turning them into Wal-Marts.
 And we recall that, unlike Target, Wal-Mart did not reported “Adjusted EPS.”
 But for those who weren’t around back then, here’s a copy of Wal-Mart’s earnings report the first year after it entered Canada:


 If Wal-Mart could report earnings without “adjusting” them, why can’t Target?
  And, what, Madam Chairman, is your definition of “Earnings”?

Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2013)    $4.99 Kindle Version at Amazon.com

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The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  And if you think Mr. Matthews is kidding about that, he is not.  The content herein is intended solely for the entertainment of the reader, and the author.

5 comments:

Anonymous said...

This has little to do with Target, but the investing public's demand for any news as soon as possible. The GAAP EPS of every publicly traded company is inevitably released on the SEC's website. Public companies know Wall Street analysts are tempted to be first in breaking any news on any stock because the public has lost interest by the time GAAP EPS is available.

Blame the public or the analysts for not having patience. Regardless, anyone who bothers with EPS, etc. knows some accounting and already knows adjusted-EPS is meaningless. Even EPS has long-term assumptions (i.e. predicting the future) about appreciation/depreciation (especially real-estate/lease heavy companies like Target), that is a fantasy relative to the Cash Flow Statement.

bjdubbs said...

Another unfortunate case of irritable male syndrome.

Anonymous said...

i wonder if Bill Gates has been talking to Buffett about CEO succession. Seems like BRK has a plan and MSFT did not. Since Gates still pulls the strings at MSFT I wonder what what kind of advice Buffett is providing and whether Gates will use him to vet the CEO candidates.

Anonymous said...

Hi Jeff, sorry for hard off topic. I was always curious how the formal part of BRK AGM looks like. How voting of so many people is quickly and efficiently conducted? (I think I read it takes a few minutes only). Thanks.

Anonymous said...

Bravo. Thanks for this.