Carl Icahn sees danger ahead.
In a new video, the billionaire Wall Street veteran warns that stock prices and corporate earnings have been propped up by an overly generous Federal Reserve pumping billions of dollars into the financial markets using crisis-era monetary policy.
As a result, rather than investing for growth, corporate managers have been employing financial engineering to manufacture earnings per share growth through M&A and share buybacks.
To make matters worse, companies have employed aggressive accounting maneuvers to accurately reporting certain costs from their publicized financial results. These adjusted items include stock compensation, restructuring costs, amortization of intangible assets, and takeover costs.
For most skeptics, the preferred measure of earnings is GAAP earnings. GAAP is short for generally accepted accounting principles, and these standards offer uniformity in how companies report their financial performance.
Income statements based on GAAP, however don’t always reflect the ongoing performance of a company’s underlying operations. For example, a company may write-down an asset or restructure its organization, a move that comes with large one-time costs companies will exclude, reporting instead an “adjusted” or “non-GAAP” earnings figure.
These adjusted numbers, Icahn suggests, inflate perceived earnings.
“If you do GAAP, which is a tougher metric, you haven’t really increased earnings for three years,” Icahn observed. “They’ve stayed at around $100 per share for three years.”
- Carl Icahn
None of this is news. However, the warnings from Icahn have been getting louder.
“The GAAP/non-GAAP S&P EPS ratio deteriorated from 94% during 1Q13-3Q14 to 78% the past 3 quarters,” Deutsche Bank’s David Bianco warned in mid-August.
But it’s not as simple as GAAP versus non-GAAP measures, with Bianco adding that, “We have always argued that the best EPS measure lies somewhere between GAAP and non-GAAP EPS.”
Even Icahn would argue that GAAP isn’t perfect either, but it does signal that the premium investors are paying for earnings growth might be higher than thought.