Non-GAAP EPS Denominator Choices

Abstract

SEC guidance about non-GAAP EPS denominator choices leads to a diversity in practice, which could reflect low-cost attempts to inflate reported EPS or corrections for deficiencies in how GAAP diluted EPS measures earnings available to claimants. We compare the denominator of non-GAAP EPS to that of GAAP diluted EPS, which differs based on whether firms report GAAP losses or GAAP profits. For firms that report GAAP losses and non-GAAP profits (loss converting firms), denominator adjustments are common and increase the number of shares (and reduce non-GAAP EPS) to mimic how the GAAP denominator calculation would be applied to profitable non-GAAP earnings. These adjustments improve the measurement of the number of future claimants and the explanatory power of EPS for the price of common equity. Loss converting firms that do not adjust the denominator, and exclude potential claims, appear to do so to maximize non-GAAP EPS. For firms that report both GAAP and non-GAAP profits (profit-profit firms), denominator adjustments are uncommon but generally increase the number of shares beyond that required under GAAP (and reduce non-GAAP EPS) and improve the explanatory power of EPS for the price of common equity. Overall, non-GAAP denominator adjustments provide useful information to investors; opportunistic denominator choices are concentrated in loss converting firms that do not adjust from the denominator of GAAP diluted EPS.