$WDAY – GAAP Toothed

by Dan March 1, 2016 3:04 pm • Commentary• Trade Ideas

Shares of enterprise cloud software provider Workday (WDAY) are up nearly 14% today after reporting fourth quarter sales that beat expectations, and grew a whopping 43% year over year (despite guiding the current qtr lower).  Sales for their fiscal year just ended were $1.16 billion, up 48% year over year.  On the surface, a company with that sort of revenue, growing that quickly, earnings that are essentially break-even (they lost 1 cent in fiscal 2016 on an adjusted basis) is forgivable, but on a GAAP basis (generally accepted accounting practices) WDAY lost $1.53 a share in fiscal 2016.  For comparison sake, much larger competitor Salesforce.com (CRM) booked a 9 cent GAAP profit in 2009, the year they topped the $1 billion in sales mark.  WOW, I can’t believe I just made a comparative valuation call in favor of CRM.  Despite the fact that WDAY trades about 8.2x trailing sales, vs CRM’s 5.5x, WDAY is likely to be a far more palatable acquisition for a larger software vendor looking to expand their cloud/SaaS offerings with a $12.8 billion market cap compared to $46 billion for CRM.

Anyway you look at it, it seems nuts to me. How do investors let managements spend their dollars the way they do and then brush the losses under the rug and report adjusted earnings that disregard the most massive expensive that most companies have, compensation?

Last week the WSJ highlighted the differential in GAAP and reported earnings for the S&P 500 (S&P 500 Earnings: Far Worse Than Advertised). This after 2015 marked the slowest eps growth for the SPX (.4%) since 2009:

Look to results reported under generally accepted accounting principles and S&P earnings per share fell by 12.7%, according to S&P Dow Jones Indices. That is the sharpest decline since the financial crisis year of 2008. Plus, the reported earnings were 25% lower than the pro forma figures—the widest difference since 2008 when companies took a record amount of charges.


The difference shows up starkly when looking at price/earnings ratios. On a pro forma basis, the S&P trades at less than 17 times 2015 earnings. But that shoots up to over 21 times under GAAP.


Indeed, outside of 2008, the only other times the GAAP gap was as wide as last year was in 2001 and 2002. That was back when companies wrote off billions of dollars worth of dot-com bubble-era investments.

These sorts of concerns seem mundane during a Central Bank induced bull market in equities, but the concern has been catching some steam in the financial press since Barron’s asked the question How Much do Silicon Valley Firms Really Earn?:

The result is an inflated and distorted earnings figure — a number that doesn’t conform with generally accepted accounting principles, or GAAP, yet is widely embraced by analysts and investors in valuing tech companies. We estimate that a dozen leading companies this year will fail to expense $16 billion in stock compensation against their non-GAAP earnings.

It’s true that tech companies also report GAAP earnings, which require the expensing of stock compensation. However, many companies highlight the non-GAAP numbers that exclude stock compensation and other expenses, including the amortization of intangible assets. Stock compensation usually is the major factor that separates GAAP and non-GAAP earnings.

Ok that was a lot, but I think it is a really important topic for investors in high valuation stocks that report adjusted earnings.  It doesn’t really matter in a bull market, but it will most definitely weigh on such stocks during market corrections like the one that we just had, where shares of WDAY decline 40% from its last tick of 2015 to its lows in early February.  And it will most certainly be a massive issue if for any reason stocks go into a protracted bear market like we had from 2000 to 2002.

Since WDAY’s post IPO ramp in 2012, making a parabolic high in early 2014, the stock found a range for the better part of 2014 and 2015, but for all intents and purposes has been in a downtrend which cracked starting last summer and imploded in January:

WDAY since IPO from Bloomberg
WDAY since IPO from Bloomberg

I suspect $80 will be staunch technical resistance in the near future, barring an event like a take-out. In the near term though, the stock could find resistance at $70:

WDAY 1yr chart from Bloomberg
WDAY 1yr chart from Bloomberg

I guess the most important take-away from the one year chart is the series of lower highs and lower lows, a failure here and the stock is likely back below $60 on the next broad market sell off.

WDAY’s 14% gains today on a slight beat, slightly lowered current quarter revenue and in line full year is quite confounding to say the least.  I can’t think of any reason to be buying this stock, in this market given the results they just gave and the possibility for greater than expected deceleration of revenue growth.   Wall Street analysts remain fairly mixed on the stock with 22 Buy ratings and 17 Holds, no sells, with an avg 12 month price target of about $75.

We will circle back on this stock as the upward momentum petters out.