Pro-Forma vs GAAP Earnings
The earnings number in the headline of an earnings release is usually not the GAAP number — it's management's own version, and the gap between the two has been widening for decades.
Prerequisites: EBITDA and Adjusted Earnings, Earnings per Share and Dilution
Open almost any earnings release and the number in the first line — "adjusted EPS of $2.10, beating estimates" — is very often not the GAAP figure. It's a company-defined pro-forma (or "non-GAAP" or "adjusted") number, built by starting at GAAP earnings and excluding whatever items management decides don't represent the "real" business that quarter.
Pro-forma earnings exclude items management judges non-representative — stock comp, restructuring, acquisition costs, amortization of acquired intangibles. Each exclusion can be defensible in isolation, but there is no external standard forcing consistency, so the gap between GAAP and non-GAAP earnings is entirely a function of what management chooses to leave out.
The rules that exist, and what they don't cover
US regulators require some discipline: SEC Regulation G requires any non-GAAP measure to be reconciled to the nearest GAAP equivalent, and Item 10(e) of Regulation S-K prohibits excluding items that are normal, recurring, cash operating expenses necessary to run the business. What neither rule does is force consistency across companies, or even across time for the same company — a firm can add a new exclusion category this year that it didn't use last year, with no requirement to flag that the definition changed.
Academic tracking of this gap (broadly, studies of the S&P 500's aggregate GAAP versus non-GAAP earnings) has found it has widened over recent decades, driven largely by the growth of stock-based compensation add-backs and by acquisition-heavy companies excluding the amortization of intangibles created by their own deal-making — an expense that, unlike a one-time restructuring charge, recurs every year a company keeps acquiring.
Worked example
A company reports GAAP EPS of $1.20. Its earnings release headlines non-GAAP EPS of $2.10, built by excluding $0.40 of stock-based compensation, $0.30 of amortization of intangibles from a past acquisition, and $0.20 of restructuring charges. The SBC exclusion ignores real dilution; the intangible amortization exclusion is standard practice (many analysts agree it doesn't reflect ongoing cash economics) but only if the company isn't continuously acquiring and thus continuously amortizing; and the restructuring exclusion is only fair if it isn't the fourth consecutive year the company has taken one.
What this means in practice
Read the reconciliation table in full, not just the headline number, and build a consistent view across the exclusions an analyst actually agrees with — dilution from SBC almost never belongs excluded from a per-share value assessment, even when it's excluded from the operating metric.
"Non-GAAP" is not synonymous with "wrong," and GAAP earnings are not automatically the "true" number either — GAAP can include real one-time noise. The point is that non-GAAP definitions are company-specific and unaudited, so they require more scrutiny, not less.
Related concepts
Practice in interviews
Further reading
- SEC Regulation G and Item 10(e) of Regulation S-K