Fundamental analysis is the first step when screening stocks for covered call writing and put-selling. Years ago I actually read the financial statements of companies I was interested in. I eventually came to the conclusion that this was an exercise in futility as it was time-consuming and, in many cases, difficult to confirm the accuracy of my analysis. Different companies used different accounting measures and sometimes one company used different measures from quarter-to-quarter to “dress-up” the quarterly reports. I know it’s hard to believe that this type of hanky-panky actually goes on (he said sarcastically). As a result, the BCI methodology uses several screens that include fundamental analysis as a triple-check on these accounting procedures:
- IBD 50
- IBD Smart Select
- Scouter Risk/Reward (the BCI team is now accessing Scouter stats for our premium members but they are not currently available to the public)
The screenshot below shows the three areas where fundamental screening takes place in our Premium Stock reports (two arrows and brown-highlighted cells):
As an example of varying accounting measures, Earnings-Per-Share (EPS) can be based on the number of shares outstanding (Basic) or on Diluted EPS which adds in options, warrants and convertible debt to the number of shares in the denominator. The latter is the more commonly used statistic. In this article, we will focus on GAAP versus Non-GAAP earnings and make a case why multiple resources should be used when evaluating and comparing a company’s financial health.
What is GAAP earnings?
GAAP is an acronym for generally accepted accounting principles. It includes things like revenue recognition, expense matching (reporting expenses and revenues in same period) and accrual accounting. Although standardization of reporting makes good sense, it may not always tell the full story when there are unusual, non-recurring revenues or expenses as with depreciation or restructuring of a corporation.
What is non-GAAP earnings?
This is when earnings are reported before interest, taxes, depreciation and amortization (paying off debt) to get a more accurate picture of a company’s cash-flow, especially since depreciation is a non-cash expense.
Other names for non-GAAP adjustments
- One-time items
- Extraordinary items
- Non-recurring charges/gains
Other names for non-GAAP earnings
- Pro forma earnings
- As-adjusted earnings
What is the role of the SEC regarding reporting of earnings?
The Securities and Exchange Commission requires that companies that report non-GAAP earnings also report the comparable GAAP financial statistics. The challenge for retail investors like us is to discern how the company arrived at the non-GAAP earnings figures. It is not practical to expect retail investors to navigate through these earnings reports and make accurate determinations. As an alternative approach, the BCI methodology uses the three screens alluded to earlier in this article as a triple check on fundamental analysis. Another way to accomplish this (for non-members) is to use a quality screen, enter a series of fundamental parameters (free cash flow, return on equity among others) and generate a list of top-performers from a fundamental perspective. An excellent free site for this is:
***My book, Stock Investing for Students, Chapter 2 lists a series of generally accepting fundamental parameters used to identify companies that are financially strong and healthy
Fundamental analysis is the first critical step used in the BCI methodology for stock screening. Earnings can be determined from a GAAP or non-GAAP perspective. This, among other accounting differences used by companies, makes if challenging for retail investors to evaluate earnings reports so it is essential we used multiple screens to double and triple-check the accuracy of our fundamental analysis.
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To register, login to the member’s site and scroll down on the left side below the store discount link. Then click on the Blue Hour sign-up link and fill out the short registration form. For members who cannot attend the event live, my team will be recording the webinar and it will be posted on the member site the following week.
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Silicon Valley (San Francisco) California
November 5, 2016- JUST ADDED
Saturday morning 3-hour workshop at the Plainview Holiday Inn. I am a guest speaker and the only speaker so if you attend you’re forced to listen to me all morning! I’ll provide registration information once I receive it from the host investment club.
Global stocks moved higher again this week despite geopolitical events in Turkey. The market is preparing for the potential for easing of the monetary policy from the Bank of Japan next week and perhaps from the European Central Bank in September. Oil prices declined this week and The Chicago Board Options Exchange Volatility Index (VIX) was static at 12.62, up from 12.52 last week. This week’s reports and international news of importance:
- Turkish president Recep Tayyip Erdogan declared a three-month state of emergency in the wake of a failed coup attempt last weekend. Standard & Poor’s downgraded Turkey’s sovereign debt rating this week to BB from BB+
- Britain’s investor confidence index dropped sharply in July, reflecting concerns that the United Kingdom’s decision to leave the European Union will weaken the European economy
- The International Monetary Fund trimmed 0.1% from its March forecasts for global gross domestic product growth. The IMF now expects the global economy to grow 3.1% this year and 3.4% next year, blaming uncertainty surrounding Brexit for the slower growth
- The flash reading of the July Markit composite purchasing managers’ index dropped sharply due to the United Kingdom’s vote in late June to leave the European Union. Markit chief economist Chris Williamson expects the UK economy to contract 0.4% in Q3
THE WEEK AHEAD
- G20 officials meet in Chengdu, China on Saturday and Sunday, July 23rd to the 24th
- The Federal Open Market Committee meets to set interest rates on Wednesday, July 27th
- The Bank of Japan meets to set interest rates on Thursday and Friday, July 28th to the 29th
- Revised Q2 US gross domestic product figures are released on Friday, July 29th
For the week, the S&P 500 rose by 0.61% for a year-to-date return of +6.41%.
IBD: Market in confirmed uptrend
GMI: 6/6- Buy signal since market close of July 1, 2016
BCI: Moderately bullish. I’m favoring out-of-the-money strikes 2-to-1 as earnings season has been decent thus far
WHAT THE BROAD MARKET INDICATORS (S&P 500 AND VIX) ARE TELLING US
Alan ([email protected])