Taking the 'Non' Out of Non-GAAP: Routine Non-GAAP Usage and Investor Pricing

Earnings are an important input for equity investors’ valuation decisions. Managers and analysts increasingly report non-GAAP earnings on an ongoing basis, routinely removing recurring items, such as amortization and stock-based compensation, from GAAP earnings. We document that by 2019, non-GAAP earnings were used in all prior eight quarters for 38 percent of firms. The routine use of non-GAAP earnings for the same firm quarter after quarter suggests that non-GAAP has become the “generally accepted” earnings measure for valuation purposes for a significant portion of publicly-traded firms. We provide evidence that routine non-GAAP usage allows investors to gain experience with non-GAAP earnings that facilitates their pricing of non-GAAP exclusions. Our findings point to a capital markets consequence of the shift from the traditional use of non-GAAP, in which adjustments are made for transitory earnings shocks, to the routine use of non-GAAP, in which adjustments are made for both recurring and transitory components of earnings.