What Is Economic Earnings Call?
An Economic Earnings Call is a scheduled teleconference or webcast held by a public company's management to discuss its financial performance, specifically focusing on "economic earnings" rather than solely relying on generally accepted accounting principles (GAAP) figures. This type of call falls under the broader umbrella of corporate finance and financial reporting, providing a perspective on a company's profitability that attempts to adjust for certain non-cash items and accounting conventions to offer a truer picture of underlying economic reality. Unlike standard financial statements that strictly adhere to GAAP, an Economic Earnings Call aims to provide a view of profitability closer to what investors might consider "cash flow" or "distributable earnings."
History and Origin
The practice of companies communicating their financial results to the public dates back decades, with formal earnings calls becoming a staple of investor relations in the latter half of the 20th century. While the general concept of an earnings call originated to provide transparency and context for reported numbers, the emphasis on "economic earnings" or non-GAAP measures gained prominence as businesses sought to highlight operational performance beyond strict accounting rules. This trend accelerated as complex accounting standards sometimes obscured the underlying cash-generating ability or core profitability of a business, leading companies to present adjusted figures they believed better reflected their true economic reality. While these non-GAAP measures can offer valuable insights, they have also drawn scrutiny for their potential to present a more favorable picture than the GAAP numbers alone, prompting discussions among analysts and regulators regarding their interpretation and reliability. Research from institutions like the CFA Institute has explored the evaluation of non-GAAP earnings measures.
Key Takeaways
- An Economic Earnings Call presents a company's financial results using non-GAAP metrics designed to reflect true economic profitability.
- It often adjusts for non-cash expenses, amortization, and other accounting conventions that may distort a company's underlying cash-generating ability.
- The goal is to provide shareholders and investors with a clearer picture of sustainable earnings.
- Such calls provide insights into management's operational perspective and future guidance beyond traditional financial reporting.
- While offering valuable context, economic earnings figures require careful scrutiny as they are not standardized and can vary widely among companies.
Formula and Calculation
While the Economic Earnings Call itself is a communication event, the core of the discussion revolves around the calculation of "economic earnings." Unlike a fixed GAAP formula, economic earnings are often a custom calculation specific to a company or industry, aiming to remove accounting distortions. A common approach involves starting with reported earnings and adjusting for specific non-cash or non-recurring items.
A simplified conceptual formula for economic earnings might look like this:
Where:
- Net Income: The company's profit as reported on the income statement, calculated as revenue minus expenses and taxes.
- Non-Cash Expenses: Items like depreciation and amortization, which reduce reported earnings but do not involve an actual cash outflow in the current period.
- Capital Charges: An imputed cost for the capital used by the business, representing the opportunity cost of investing in the business rather than elsewhere. This is a crucial element that distinguishes economic earnings from accounting earnings.
- Other Adjustments: This can include a wide range of company-specific adjustments, such as removing the impact of one-time events (e.g., asset sales, significant restructuring costs) or accounting policy changes that obscure core operational performance.
The exact components of "Other Adjustments" can vary significantly, which is why transparency in reporting these figures during an Economic Earnings Call is vital for financial analysts.
Interpreting the Economic Earnings Call
Interpreting an Economic Earnings Call requires looking beyond the headline numbers and understanding the adjustments made to arrive at the "economic earnings" figures. Investors and analysts often use these calls to gain insight into a company's true operational profitability and its ability to generate cash over the long term, rather than just its short-term accounting profit. By focusing on economic earnings, investors attempt to gauge the sustainable earning power of a business, which can be particularly useful for valuation models. During these calls, management will typically explain the rationale behind their non-GAAP adjustments, providing a narrative that supplements the raw financial data. A key aspect of interpretation involves comparing the economic earnings to consensus market expectations and understanding how the company's adjusted figures align with its stated business strategy.
Hypothetical Example
Consider "Tech Solutions Inc.," a software company holding its quarterly Economic Earnings Call. For the quarter, Tech Solutions reports a GAAP Net Income of $50 million. However, during the call, the CEO highlights that the company's "economic earnings" were $75 million.
The CEO explains the reconciliation:
- GAAP Net Income: $50 million
- Add back Depreciation & Amortization: Tech Solutions had $15 million in non-cash depreciation and amortization expenses that reduced their GAAP net income. Adding this back provides a better sense of cash generated from operations.
- Add back Stock-Based Compensation: The company issued $5 million in stock-based compensation, a non-cash expense that is often added back to economic earnings.
- Subtract Impairment Charge: Tech Solutions took a $5 million non-recurring impairment charge on an old asset, which management believes does not reflect ongoing operational profitability. This is not added back as it's a real loss, but it's often clarified as non-recurring.
- Adjust for Capital Charge: For illustrative purposes, imagine they estimate a "capital charge" (cost of capital deployed) of $10 million that GAAP doesn't account for, reflecting the true economic cost of maintaining and growing the business.
Therefore, the reported economic earnings calculation would look like this:
$50 \text{M (Net Income)} + 15 \text{M (D&A)} + 5 \text{M (Stock Comp)} - 10 \text{M (Capital Charge)} = $60 \text{ million}$.
(Self-correction: The initial example calculation led to $75M. I adjusted it to $60M to better reflect the conceptual formula and avoid confusion about the impairment charge as a subtraction.)
This $60 million figure represents the company's economic earnings, which is what the management emphasized during the call as a more accurate reflection of their sustainable operational profitability. Analyst calls following this presentation would delve into these adjustments.
Practical Applications
Economic Earnings Calls are primarily used by publicly traded companies to communicate their financial results to shareholders, analysts, and potential investors. These calls serve as a crucial platform for management to provide context for their reported numbers, offer forward-looking guidance, and answer questions about the company's strategic direction and financial performance. Investors rely on the information presented during these calls, alongside formal filings, to make informed investment decisions and perform comprehensive due diligence. The insights gained can influence stock prices and affect analyst ratings. The ability to access company filings and official communications, such as those available through the U.S. Securities and Exchange Commission's EDGAR database, is fundamental to understanding a company's financial health.
Limitations and Criticisms
While Economic Earnings Calls aim to provide greater clarity, they are not without limitations and criticisms. The primary concern revolves around the lack of standardization in how "economic earnings" are calculated. Unlike GAAP earnings, which follow a strict set of accounting rules, economic earnings are essentially pro forma earnings tailored by each company. This flexibility can lead to inconsistencies between companies and even between different reporting periods for the same company, making comparisons difficult. Critics argue that some companies may use these adjustments to present an overly optimistic view of their profitability by excluding expenses they deem "non-recurring" or "non-operational" but which are, in reality, regular occurrences.
For instance, a study published in the University of Chicago Booth School of Business's Ignite publication questions whether non-GAAP earnings truly matter to investors, highlighting the complexity of their interpretation. Regulatory bodies, such as the U.S. Securities and Exchange Commission (SEC), provide guidance on the use of non-GAAP financial measures to ensure that companies do not mislead investors, emphasizing the importance of clear reconciliation to GAAP figures and balanced presentation. The potential for companies to "cherry-pick" adjustments can undermine investor confidence and reduce transparency, making it crucial for investors to understand the specific adjustments being made during an Economic Earnings Call.
Economic Earnings Call vs. Financial Earnings Call
The terms "Economic Earnings Call" and "Financial Earnings Call" are closely related and often used interchangeably, but a subtle distinction exists. A Financial Earnings Call is the broader term for a scheduled conference where a company discusses its quarterly or annual financial performance, typically focusing on the figures reported according to GAAP or International Financial Reporting Standards (IFRS). This call covers the official results presented in the company's audited or reviewed financial statements.
An Economic Earnings Call, however, places a specific emphasis on "economic earnings" or other non-GAAP financial measures. While a standard Financial Earnings Call will touch upon GAAP net income, revenue, and expenses, an Economic Earnings Call specifically drills down into adjusted figures that management believes better represent the underlying profitability and cash-generating capability of the business. The confusion arises because most financial earnings calls today incorporate discussions of both GAAP and non-GAAP results. Therefore, an Economic Earnings Call can be considered a specific type or a more detailed segment within a broader Financial Earnings Call, distinguished by its focus on adjusted, often proprietary, performance metrics.
FAQs
What is the primary purpose of an Economic Earnings Call?
The primary purpose is to provide investors and analysts with a detailed explanation of a company's financial results, specifically highlighting "economic earnings" or adjusted non-GAAP figures that management believes offer a more accurate representation of the company's core profitability and operational performance.
How do "economic earnings" differ from GAAP earnings?
GAAP earnings strictly adhere to a standardized set of accounting principles, focusing on historical costs and accrual accounting. "Economic earnings," conversely, are non-standardized measures that attempt to adjust GAAP figures by removing certain non-cash items (like depreciation) or non-recurring expenses to show a company's sustainable earning power and true cash generation.
Who typically participates in an Economic Earnings Call?
Company executives, including the CEO, CFO, and other senior management, typically lead these calls. Participants listening in usually include equity analysts, institutional investors, financial media, and sometimes individual shareholders.
Are the figures discussed in an Economic Earnings Call audited?
While the underlying GAAP financial statements are audited, the "economic earnings" or non-GAAP figures themselves are typically not directly audited. However, companies are generally required to reconcile these non-GAAP measures to their closest GAAP equivalent, and this reconciliation might be reviewed by auditors in conjunction with the audited financial statements.
Why do companies provide economic earnings figures if they are not standardized?
Companies provide economic earnings figures to give a clearer picture of their operational performance, believing that GAAP figures might sometimes obscure the true economic reality of their business due to specific accounting rules or one-time events. They aim to offer greater transparency and help investors understand core profitability and future prospects.