I was reading the earnings call transcript from Ford motor company last week. It was a good case study in GAAP vs non GAAP.
Ford had a good year in 2016. Before special items they had a near record year in profits of $10.4 billion in profits. However, GAAP earnings includes special items. Ford maintains a huge pension. To estimate their expense in any given year they have to comply with various arbitrary rules including setting a discount rate. If the discount rate goes down in any signficant way Ford has to report a big expense for pension. That is what happened. Ford had to report a $3 billion expense to comply with GAAP. It was a "one time" adjustment to the valuation of the pension.
So GAAP earnings for Ford was much lower in 2016 than adjusted operating earnings. But, it was a NON CASH expense. Moreover it was to pensions. Its completely useless in knowing how Ford is performing in operationally in the current year. For anyone wanting to know how Ford performed operationally over the year then it is necessary to remove that pension expense. Adjusted earnings does that. That is a good thing and important.
On the other hand, just because a pension adjustment is a non cash expense based on some arbitrary GAAP rule doesn't mean it isn't real. Over recent years bond yields have kept going down and down. For pension funds trying to generate low risk cash flows to meet their pension obligations, that is a big problem that has to be accounted for.
Sure enough, buried in Ford's conference call, management said that Ford will have to pay $200 million/year more into their pension fund for the foreseeable future. In other words, that $3 billion non cash expense for pensions kind of is a cash event. Moreover, that $200 million extra Ford has to pay in cash in future years will be a payment that is not reported as an expense. Therefore non-GAAP adjusted earnings will look better than it really is.
Point is, there is a good reason to use GAAP earnings. Its not some annoying method of accounting that forces corporations to include expenses that are not really expenses to under report profits. It is true that in any given year GAAP rules requires companies to report "one time" adjustments that do not reflect the current year. But that is why CAPE is a good metric to use. By using GAAP earnings over a 10 year period it smooths out those adjustments. Not to mention the cyclical ups and downs. of a company.