GAAP vs. Non-GAAP Earnings (Adjusted Earnings)
GAAP net income is the official, audited profit. Non-GAAP or adjusted earnings are figures companies calculate themselves by removing items they consider unusual or non-cash. The gap between the two is one of the first things to check in an earnings release.
How to calculate it
Adjusted earnings = GAAP net income + items management excludes (commonly stock-based compensation, amortization of acquired intangibles, restructuring charges, acquisition costs, impairments, litigation, gains and losses on investments) ± tax effect of those adjustmentsAdjusted EPS = adjusted earnings ÷ diluted sharesHow to read it
- Start from the reconciliation table. SEC rules require a company that publishes a non-GAAP measure to show the most directly comparable GAAP measure with equal or greater prominence and reconcile the two.
- If GAAP and adjusted earnings stay close for years, profit mostly comes from the core business. A large, persistent gap means you need to judge each adjustment yourself.
- Watch which way the adjustments go. Companies almost always add back costs; few remove one-time gains with the same enthusiasm.
Common pitfalls
- Recurring costs are not one-time. Restructuring charges that appear every year, and stock-based compensation, which is a real cost to shareholders through dilution, are the most debated add-backs.
- Each company defines its own adjusted figures, and definitions can change over time. Compare a company's adjusted numbers only with its own history, using the same definition.
- Analyst consensus 'EPS beats' are usually measured against adjusted EPS, not GAAP EPS.
- A GAAP loss with an adjusted profit means the business only looks profitable after the company's own adjustments.
Industry differences
Software and biotech companies, where stock-based compensation is large, and serial acquirers, which amortize large intangibles, tend to show the widest GAAP-to-adjusted gaps.
Where to find it in a 10-K
The earnings release (furnished on Form 8-K, usually as Exhibit 99.1) contains the non-GAAP reconciliation. The 10-K itself reports GAAP figures; some companies repeat non-GAAP measures in MD&A with a reconciliation.
U.S. vs. China reporting
China's A-share version of this idea is mandatory and standardized: every annual report shows net profit after deducting non-recurring gains and losses, using a CSRC list of what counts as non-recurring, and auditors review it. U.S. adjusted earnings are voluntary and defined by management under SEC disclosure rules (Regulation G and Item 10(e) of Regulation S-K), so they are more flexible and more prone to flattering adjustments.