Home Accounting and Auditing The ‘Earnings Recovery’ Remains An Accounting Mirage

The ‘Earnings Recovery’ Remains An Accounting Mirage

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Economic earnings remain in a persistent downturn.

This disconnect between accounting earnings and economic earnings is not just due to a handful of companies, writes David Trainer.

The breadth of this decline in economic earnings suggests that the majority of U.S. public companies are unable to earn a ROIC greater than their WACC.

On January 11, 2018, we showed that the “earnings recovery” is an illusion. U.S. equities] may have rebounded from 2015 lows, but economic earnings – which reverse accounting distortions and account for the weighted average cost of capital (WACC) – remain in a persistent downturn. Figure 1 shows this trend.

Figure 1: Economic vs. GAAP Earnings

GAAP vs. Economic Earnings: Total Market

Sources: New Constructs, LLC and company filings.

This disconnect between accounting earnings and economic earnings is not just due to a handful of companies. 6 out of 11 sectors have misleading earnings (GAAP rising and economic earnings falling) in the last fiscal year. Over the last twelve months, six sectors have negative economic earnings, and just two sectors, Technology and Healthcare, have positive and rising economic earnings.

The breadth of this decline in economic earnings suggests that the majority of U.S. public companies are unable to earn a return on invested capital (ROIC) greater than their WACC on new investments. In other words, the majority of U.S. companies are struggling to find profitable ways to allocate capital.

The Tech sector is one of only two sectors with rising and positive economic earnings. But, the economic earnings picture is not as rosy as GAAP earnings would suggest. While GAAP net income has risen 9% over the past five years, economic earnings are only up 7%. Tech companies also have the most excess cash of any sector, at $1.1 trillion, a sign that they are also struggling to find profitable growth opportunities.