When Buying Tech Stocks, Mind the GAAP

Markets Motley Fool

In this Motley Fool Answers video, Alison Southwick and Robert Brokamp welcome Dylan Lewis, host of Industry Focus: Tech, to the show to offer his thoughts on the difference between the profit and revenue numbers management teams want to highlight, and the GAAP figures that they're required to provide.

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A full transcript follows the video.

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This video was recorded on June 27, 2017.

Alison Southwick: The third thing you need to know before you invest in a tech stock is to please mind the GAAP.

Dylan Lewis: That was a good one!

Southwick: Hey, thanks! By which we mean the acronym for "generally accepted accounting principles." And here's where I'm going to have to nudge Bro every now and then. I don't know. Are you going to stay awake?

Robert Brokamp: Were you talking? What? Huh?

Southwick: Yeah. Let's talk generally accepted accounting principles.

Lewis: Riveting stuff, right? This is important, because the tech space is notorious for its fun-with-numbers approach to accounting. All public companies have to submit financials that are put together using the GAAP approach. And the idea there is these are reporting standards that all companies that are publicly traded have to comply with for regulatory purposes. And really they help investors and everyday people just make apples-to-apples comparisons on companies and just understand what's going into the numbers that they're seeing.

On top of that, companies can offer non-GAAP numbers, and so these are financials that are not GAAP-compliant but the company might feel that it helps illustrate what's going on with their business. And very often because they are high-growth and unprofitable companies, tech companies will report GAAP and non-GAAP numbers in their quarterly results. And it's not necessarily a bad thing, but I think it's just important to understand which one is which and why the company might be doing that.

Just an example that helps illustrate it. Twitter lost $62 million last quarter if you're looking at GAAP financials, but the company focuses on a metric that they like to tout, adjusted EBITDA, which was positive $170 million. You say how? That's a $230 million swing.

That $170 million figure is a non-GAAP number, and it excludes things like stock-based compensation, which was $117 million during the quarter.

There's debate about how people should treat stock-based compensation for accounting purposes, but for GAAP you need to include it as an expense. Stock-based compensation is particularly important in tech, because a lot of firms use it to bake it into the compensation packages. Like they are high-growth businesses, and it's just a good way to provide compensation and equity for people. But it comes at an expense, and businesses need to recognize that.

So just taking a second to look at GAAP versus non-GAAP numbers for companies that you're interested in and the reconciliation there can be really helpful.

Southwick: Where should someone go to get all up on their GAAP education? To learn more about GAAP?

Lewis: You'll hear companies go through it in their conference calls very often. They'll talk about their GAAP numbers and they'll talk about their non-GAAP numbers. Very often analysts will ask questions that poke at the difference, so you can get some of that there. But they also have to put out reconciliations. Twitter, for example, on their investor-relations page, has their slides that reconcile how you get from that net-loss number to that positive EBITDA number. For regulatory purposes they have to make that available.

Southwick: So just dig a little farther and you'll find it.

Lewis: Yup.

Alison Southwick has no position in any of the stocks mentioned. Dylan Lewis has no position in any of the stocks mentioned. Robert Brokamp, CFP has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Twitter. The Motley Fool has a disclosure policy.