Corporate profits

Corporate earnings have been much less volatile than implied by GAAP earnings

Corporate earnings, when properly measured, have been much less volatile than GAAP earnings suggest since Q1 2020.

This report is an abridged version of S&P 500 & Sectors: Core Earnings Vs. GAAP Earnings Through 3Q21, one of my series of quarterly reports on fundamental market and industry trends. The full version of the report analyzes basic income[1] and the GAAP earnings of the S&P 500 and each of its sectors.

Generally accepted accounting distortions

Figure 1 below shows that basic earnings, which adjust for unusual gains / losses, are less volatile than GAAP earnings. For example:

  • In 2020, GAAP earnings fell 30% year-on-year, compared to an 18% decline for core earnings.
  • In 2021, GAAP earnings increased 81% through 3Q21, compared to a 46% increase in core earnings.

At the end of 2020, basic profit of $ 1.1 trillion was 21% higher than GAAP profit of $ 877 billion. Today at $ 1.5 trillion, core earnings are 3% lower than GAAP earnings of $ 1.6 trillion.

Figure 1: Basic benefits of the S&P 500 versus results. Year-over-year percentage change in GAAP profit: 1Q20 – 3Q21

My company’s basic profit analysis is based on aggregated TTM data for industry constituents over each measurement period.

The measurement period of November 16, 2021 incorporates financial data from the 3Q21 10-Qs calendar, as this is the first date for which all 3Q21 10-Qs calendars for S&P 500 components were available.

GAAP 2021 profits largely overestimated

For 220 S&P 500 companies, at 44%, GAAP earnings overstate basic earnings for the last twelve months (TTM) of the calendar ended 3Q21. Surprisingly, when GAAP profits overestimate core profits, they do so by an average of 534% per company, according to Figure 2. The overestimation accounted for more than 10% of GAAP profits for 21% of companies.

The 220 companies with overstated GAAP earnings represent 57% of the S&P 500 market capitalization, which is the highest percentage since 2012 (first data available). See figure 3.

Figure 2: Overvalued GAAP Profits[2] by 534% on average

* Includes Southwest Airlines (LUV), whose GAAP earnings are over 99,000% overstated. If I remove LUV, the overestimated average% is 90%.

Figure 3: Overvalued / Undervalued Profits as% of Market Cap: 2012 to 11/16/21[3]

Key details on some sectors of the S&P 500

Core earnings increased year-on-year for all eleven sectors of the S&P 500 in 3Q21, broadening the improvement from nine sectors in the second quarter. The energy sector saw the biggest year-on-year percentage improvement in core earnings, which rose from $ 1.3 billion in 3Q20 to $ 34.5 billion in 3Q21.

The tech sector generates the most core profits of any industry and grew core profits 44% year-on-year in 3Q21. On the flip side, the real estate sector has the lowest core earnings, and the consumer discretionary sector had the weakest year-on-year growth in 3Q21.

Below, I highlight the Industrials sector and a stock with one of the biggest earnings distortions (i.e., overstated GAAP earnings) in the industry.

Example of sector analysis: industrial sector

Figure 4 shows core industry profits, at $ 101.7 billion, increased 36% year-on-year in 3Q21, while GAAP profits, at $ 109.1 billion, increased 79%. % during the same period. Core earnings and GAAP earnings were hit more severely during COVID-19 than during the financial crisis, but recovered faster.

Figure 4: Basic profits of industrial products vs. GAAP: 2004 – 3Q21

My company’s basic profit analysis is based on aggregated TTM data for industry constituents over each measurement period.

The measurement period of November 16, 2021 incorporates financial data from the 3Q21 10-Qs calendar, as this is the first date for which all 3Q21 10-Qs calendars for S&P 500 components were available.

GAAP Profit Overstatement Details: United Airlines (UAL)

Below, I detail the hidden and reported unusual items that are not captured in GAAP earnings but are captured in core earnings for United Airlines (UAL), an action with some of the most significant earnings distortions, and therefore overestimated GAAP profits in the industrial sector. Adjusting for unusual items, I see United’s basic earnings of – $ 19.74 / share to be almost 2 times worse than reported GAAP earnings of – $ 10.15 / share. United Airlines Profit Distortion Score is Strong Miss. My stock rating for UAL is very unattractive.

Figure 5 details the differences between Basic Profits and GAAP Profits so that readers can audit my research.

Figure 5: Reconciliation of United Airlines GAAP earnings to core earnings

The main sources of distortion for LAU – including federal subsidies from the CARES Act subsidies, severance costs and benefits, gains / losses on sale of assets and depreciation of assets detailed below- below – have been grouped together under “special charges (credit)” on United Airlines revenue reporting. I found the additional details in the management discussion and analysis section of the documents filed by the company.

More details:

Unusual earnings reported before tax, net = $ 11.99 / share, which equates to $ 3.8 billion and includes:

$ 4.5 billion in other non-recurring revenue during the TTM period based on

$ 192 million in unrealized gains on investments during the TTM period based on

-58 million dollars of miscellaneous expenses during the TTM period based on

– Matching adjustment of $ 91 million for recurring retirement costs. These recurring expenses are reported in non-recurring line items, so I add them back and exclude them from the income distortion.

– $ 305 million depreciation of asset charges during the TTM period based on

– $ 595 million in severance and benefits during the TTM period based on

Tax distortion = -2.40 $ / share, which is equivalent to -760 million dollars

  • I remove the tax impact of unusual items on declared taxes when I calculate base income. It is important that taxes are adjusted so that they are appropriate for adjusted pre-tax profits.

Disclosure: David Trainer, Kyle Guske II, and Matt Shuler receive no compensation for writing about a specific action, style, or theme.

Annex: Calculation methodology

I derive the above GAAP core earnings and earnings measures by summing the individual S&P 500 constituent values ​​for the past twelve months for core earnings and GAAP earnings in each industry for each measurement period. I call this approach the “Aggregate” methodology.

The Aggregate methodology provides a straightforward snapshot of the entire industry, regardless of market capitalization or index weight, and is the way S&P Global (SPGI) calculates metrics for the S&P 500.

[1] Based on the latest audited financial data, which is the 10-Q for the 3Q21 schedule in most cases.

[2] Overvalued companies include all companies with an earnings distortion greater than 0.1% of GAAP earnings.

[3] Overestimated GAAP profits correspond to a profit distortion> 0.1% of GAAP profits.