Individual Analysts’ Non-GAAP Earnings Exclusions and Target Prices

Abstract

Researchers often do not distinguish non-GAAP exclusions that increase earnings from those that decrease earnings, overlooking the fact that EPS-decreasing exclusions (about one fifth of all analysts’ exclusions) could have different properties and valuation implications. Using both hand-collected analyst reports and large samples from I/B/E/S and Compustat, we document how analysts’ EPS-decreasing exclusions differ from their EPS-increasing exclusions in both the type and timing of the earnings items being excluded, underscoring the need to study the two kinds of exclusions separately. We find that EPS-decreasing exclusions are positively associated with analysts’ optimism incentives in the same way as EPS-increasing exclusions are. This optimism manifests in analysts’ target prices, which are more optimistic (both ex ante and ex post) when analysts make either type of exclusion. Further evidence suggests that when analysts make EPS-decreasing exclusions, they tend to over-estimate firms’ growth prospects, and investors discount the resulting valuation optimism.