MorningWord 5/27/16: Fall into the GAAP

by Dan May 27, 2016 9:27 am • Commentary

The financial media has spilled a lot of ink on the growing gap between GAAP and Adjusted Earnings. I’ve also written on the subject at times, choosing to focus on a stock by stock basis (here, here, here) as opposed to the impact on valuation for the broad market. On the broader market, there has been some good stuff from CNBC, Bloomberg, Barron’s, WSJ, Warren Buffett and even Zerohedge :

Mind the GAAP

How Much Do Silicon Valley Firms Really Earn?

Paying a Price in the Stock Market for Pro Forma Earnings Tricks

S&P 500 Earnings: Far Worse Than Advertised

Something fishy is going on with earnings

Mind The Non-GAAP: Real S&P Earnings Are The Lowest Since 2010

Why Companies Don’t Want You To Look At GAAP Earnings

Yesterday, on-the-line security vendor Palo Alto Networks (PANW), which trades 90x earnings and 10x sales, reported disappointing fiscal Q3 eps. It was a gain of 40 cents but a loss of 80 cents on a GAAP basis.  Here were my thoughts heading into the print from my preiew:

My concern with PANW has always been valuation, and what seemed like a universal bullishness about the stock and the company’s prospects. on an adjusted basis, PANW is expected to earn 1.66 per share in fiscal 2016, on a GAAP basis, the company is expected to lose 2.29, that’s a greater GAAP loss than fiscal 2015’s $2.02, despite an expected year over year sales increase of nearly 50%, what the hell are these guys spending on customer acquisition??

PANW is down 10% in the pre-market, likely on its way back towards its 52 week lows. What’s shocking to me about this stock was the overwhelmingly bullish stance by Wall Street analysts (38 Buy ratings, only 3 Holds and NO Sells, with an average 12 month price target $195), despite the stock’s 17% ytd decline and 27% decline from its 52 week an all time highs heading into the report.

Are Wall Street research analysts so blind to rational valuation metrics? They model in both GAAP and Adjusted, but they offer their price targets and valuation metrics in GAAP terms. This is a total joke. And for any of you who recall the dotcom bubble aftermath in the early aughts there will be a day of reckoning for dozens of multi-billion market cap stocks that have been misjudged by investors and analysts alike.

To see some of this in action, look no further than PANW peer FireEye (FEYE). It’s down 85%. Or 3d printing stocks like 3d Systems (DDD) down nearly 90%, or Yelp Inc (YELP) down 75%, all from their 2014 all time highs.  All stocks with massive gaps between GAAP and Adjusted.

Still mind the GAAP gap. This time around it may not even take a bear market or even a market correction for this to be exposed. Investors are starting to pay attention to what’s real and what’s not already.