GAAP vs Adjusted — Reading the Fine Print

Two earnings numbers

GAAP earnings follow accounting rules — every cost counts. "Adjusted"/non-GAAP earnings exclude management's chosen items: stock comp, restructuring, "impairments," acquisition costs. Management picks the exclusions, so the adjusted number is a marketing artifact by default. The honest analyst treats the GAP between them as a recurring cost, not a one-off.

The stock-comp question

Stock-based compensation is the classic exclusion — yet it is a real cost: it dilutes you (day 1's share-count lesson). Companies reporting "$5 adjusted EPS, $3 GAAP" because of SBC are paying employees with your ownership. Watch SBC as a % of revenue: >10% in a mature company is a red flag; it also inflates "free cash flow" since SBC is non-cash.

The rule

Value the business on GAAP earnings (or cash flow), use adjusted numbers only to understand management's narrative. When the gap between adjusted and GAAP widens year after year, the "one-time" items are the business model.

Sources

• Non-GAAP MeasuresInvestopedia
• Berkshire Hathaway Shareholder LettersWarren Buffett