Subscriber Scott D wrote to ask:

"I'm curious why you employ non-GAAP measures in the analyses you make on some stocks when we are generally advised to avoid them, even by BetterInvesting. Basically, as I understand it, non-GAAP measures mostly hide unfavorable results."

For beginners, it’s often best to rely on GAAP data when analyzing individual companies. GAAP stands for "Generally Accepted Accounting Principles," and provides a framework for presenting financial statements for businesses in the U.S.

But there are many situations where a study of non-GAAP data can provide additional insight into a company’s core fundamentals and potential for future organic growth. The focus of the BetterInvesting approach is on identifying companies that have the right attributes for long-term growth, with an emphasis on a company's ability to generate consistent profits from its operations. But because of the rigidity of the GAAP framework, operating results can sometimes be obfuscated by data reporting requirements. In these cases, a review of adjusted data can be extremely useful in understanding a company's underlying growth potential.

For example, a company that has bought or sold a business unit in the year could see its GAAP results paint one picture, but non-GAAP data that includes past results from an aquired business or excludes results from a sold business could affect your determination of how well a company might grow in the future.

To be sure, adjusted data can also sometimes mask underlying trends, but this is where a basic understanding of financial statement analysis is invaluable to an individual investor's success in selecting stocks.

For companies in some industries, such as Real Estate Investment Trusts (REITs) or financial services companies, the use of non-GAAP data is standard and a well-recognized method of analyzing those securities using the BetterInvesting approach.

While adhering to a blanket policy such as “Always use GAAP data” can prevent an investor from buying a company that might not be well-positioned for future returns, it also eliminates some companies from consideration that might be poised to deliver results in the future.

This is part of the value-added proposition of subscribing to the Investor Advisory Service or SmallCap Informer newsletters – you can rely on experienced analysts to review the data and provide expert guidance.

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