What Adjusted Earnings Tells Investors

When deciding whether to invest in a company, a variety of different metrics are available. This includes net income, earnings before interest, taxes, depreciation and amortization (EBITDA) or adjusted earnings. All of these gauge a company’s financial health, but in different ways. When reviewing adjusted earnings, it’s important to understand how it works as a guideline when making decisions in your portfolio.

For hands-on help evaluating whether an investment is a smart decision for you, ask a financial advisor.

What Are Adjusted Earnings?

Before diving into adjusted earnings, it’s helpful to first understand how companies manage their accounting practices.

Generally accepted accounting principles (GAAP) are a set of standards and guidelines publicly traded companies use to prepare financial reports. It is more or less a uniform accounting framework for reporting items such as earnings and profit and loss.

Non-GAAP reporting is an alternative way to track a company’s financial performance. Adjusted earnings is a non-GAAP reporting metric allowing companies to adjust earnings by excluding large one-time expenses or losses that would ordinarily not be considered part of the operating status quo. For example, if a corporation undergoes a large-scale restructuring, those costs could affect earnings for the year.

Why Companies Use Adjusted Earnings

There are different ways companies can measure and report financial performance.

Net Income

Net income measures sales minus the cost of goods sold and other expenses, such as operating costs, depreciation and taxes.

How to Calculate Net Income

Net Income = Sales – (Cost of Goods Sold + Expenses + Interest + Taxes)

Calculating the gap between a company’s revenue and its expenses can help you discern whether it’s spending more than it earns.

EBITDA

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) can be used as an alternative to net income. This metric indicates how profitable a company is and how well it has performed over a given period.

EBITDA offers an apples-to-apples comparison between companies in the same industry or sector.

Adjusted Earnings

Adjusted earnings apply when a company incurs a large expense or significant one-time gains separate from regular operating expenses.

With adjusted earnings, they can offset expenses and gains to more accurately assess the company’s financial health. This is common when companies are hoping to attract investors and raise capital, or are seeking debt financing.

An adjusted earnings figure excluding sizable one-time costs can improve the business’s bottom line. This can potentially sway investors to buy shares or banks to lend money.

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Why Adjusted Earnings Can Be Problematic for Investors

An investor reviewing stock performance.

While there are some benefits to publishing adjusted earnings for companies, there are some potential pitfalls for investors.

The biggest disadvantage is that because adjusted earnings are a non-GAAP measure, companies can easily manipulate these reports by excluding costs that shouldn’t be excluded. For example, in addition to one-off expenses, companies might omit basic everyday operating expenses to make a company look better on paper.

What happens is that an investor may look only at adjusted earnings to gauge financial performance. If adjusted earnings look good, they may invest only to find trouble later when the company runs into financial trouble.

On the flip side, companies can use adjusted earnings to highlight one-time earnings boosts that omit temporary costs. This is problematic because an investor may buy shares expecting earnings to continue. Later, they find themselves disappointed when the company’s performance returns to normal.

Where to Find Adjusted Earnings

Companies often report adjusted earnings alongside their GAAP results in quarterly earnings releases and investor presentations. Public companies generally explain which expenses or gains were excluded. They provide a reconciliation showing how they calculated the adjusted figure.

Comparing adjusted earnings with GAAP earnings can help you determine whether the adjustments are relatively small or have a significant effect on the company’s reported results. A large difference between the two figures may warrant a closer look at the excluded items.

Pay attention to the types of adjustments a company makes from one reporting period to the next. One-time restructuring costs or the sale of a business may be reasonable adjustments. If a company excludes similar expenses year after year, however, they may represent recurring operating costs rather than unusual events.

Reading the notes accompanying an earnings release can provide additional context about the company’s adjustments. Management typically explains why it believes adjusted earnings provide a useful measure of operating performance. It describes the items that were added back or removed.

Analyzing both GAAP and adjusted earnings instead of a single measure can provide a comprehensive picture of financial performance. Comparing multiple reporting periods helps identify whether adjustments are truly unusual or have become a recurring part of the business.

How to Evaluate a Company Using Adjusted Earnings

There are a few factors to consider when using adjusted earnings to compare companies as an investor.

Earnings and expenses. It’s important to look closely at how the company reports earnings and expenses. Specifically, it’s important not to focus on just one-time expenses or gains.
Operating expenses. Ensure the company is accurately reporting its day-to-day operating expenses. If there is a large one-time expense or gain, look at the reason for it. Consider how it may affect short- and long-term profitability.
Historic trends. Consider how adjusted earnings have trended over time. For example, have adjusted earnings been on a steady upward trajectory, or do the numbers spike up and down? If a company is reporting adjusted earnings for the first time, ask yourself why.
Compare ratios. Review other financial ratios to get a better sense of what’s happening with a company financially. For example, earnings per share measures the net income attributable to each share of common stock. When earnings per share is zero or negative, that means the company has zero or negative earnings.
Price-to-earnings ratio. The price-to-earnings ratio represents the share price of a company’s stock divided by earnings per share.¹ This number can be used to gauge how much you could potentially earn by purchasing shares of stock in a particular company.
Other financial ratios. Calculate and consider financial ratios, such as these.

Bottom Line

Adjusted earnings can offer insight into a company’s financial outlook. However, it’s important to consider where those numbers come from and their accuracy. Using adjusted earnings, alongside net income, EBITDA and other financial ratios can be a helpful way to evaluate a company’s finances. The more information you have on a company’s financials, the easier it can be to make an informed decision about whether to invest.

Tips for Investing

Consider talking to a financial advisor about what adjusted earnings means and how to decode it when reviewing investments. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
When comparing investments, consider whether it makes more sense to use a fundamental or technical approach. Fundamental analysis involves digging into a company’s fundamentals, i.e. exploring its financial statements to determine its underlying value. Technical analysis, on the other hand, is more concerned with stock price movements and how those are affected by current and near-term trends. Understanding how the two differ and how they can be used together can help you fine-tune your investment strategy.