Pro forma earnings do not include unusual or infrequent transactions. Items excluded include amortization, depreciation, goodwill, and other expenses. The usual intention of these exclusions is to present a clearer picture to investors. But really, is doing so beneficial or potentially detrimental to the statement user who is not cautious? Pro forma figures typically make a firm look for profitable than GAAP figures. Simply put, it is the “earnings before the bad stuff.” The study explores the company’s defense that pro forma earnings provide a better picture for forecasting and if it causes a stock market reaction.
In 2001, General Motors opted to exclude legal settlement costs. In my opinion, it is fair to exclude legal costs as it is not part of a company’s future cash flows/potential, even though the event can reoccur. Regardless, it is up to management whether to include it or not, and it is up to the user to effectively make their decisions.
Since a company is free to use pro forma calculations over that of GAAP, I feel that so long as that is clearly emphasized, it is up to the user to “use” and invest accordingly. I don’t see it as manipulative since an investor should be educated enough to know of the risks involved, and that footnotes are not to be ignored. If not, perhaps he should not be investing, and/or rather paying someone who does know how to properly read the statements to do the reading for him.
The study, however, concludes that exclusions can predict lower future cash flows, and in turn, has a negative effect on stock returns. Earnings announcements cause reactions. But parallel to my thoughts above, it was also concluded that the market can simply be fooled. It may not actually be due to negative implications of future cash flows depending on the excluded expenses.