I love stock screens. They’re a great way to save time on your investing research. But one of the biggest shortcomings of stock screens is that they use Generally Accepted Accounting Principles (GAAP).
Now keep in mind…
I’ve written before about what happens when stock screens go wrong. But this GAAP shortcoming of stock screeners can be especially costly. It can also make you miss out on a ton of opportunity. So what’s the GAAP shortcoming all about?
GAAP Stock Screen Shortcoming Explained:
While you obviously need accounting standards to compare companies, the world is a complex place. And sometimes the standards don’t accurately reflect what’s actually going on at the company.
This can work in both negative and positive ways and it’s just something investors should be aware of. So…
In the example below you’ll see an example of how GAAP stock screens might have cause you to miss an investment opportunity.
UTHR GAAP Stock Screen Shortcoming Explained:
But despite the high price to earnings ratio, UTHR is yielding quite a bit of free cash flows. And revenue are really starting to climb while share count has decreased over the last few years. One red flag is the recent UTHR insider selling. But otherwise the company looks to have a strong record of revenue growth.
Take a look at the key stats from Morningstar for yourself…
UTHR looks to be growing. But in the last year the EPS has dropped in half. This is why it’s not showing up on my favorite stock screens. But what’s this earnings anomaly all about?
I think it’s worth investigating a little further.
In taking a look at the latest UTHR conference call, management is quick to address their EPS shortfall. You’ll want to dig in a little further. But this seems pretty plausible when taken in context with the revenue growth…
If you’re taking a look at the financial results, you’ll notice that the GAAP earnings per share showed a loss for the year. However, this is simply an artefact of the accounting treatment for the share tracking awards which we issued to our employees in lieu of equity-based stock compensation or restricted shares. These types of share tracking awards are required by the accounting rules to be mark-to-market every quarter.
And continuing on the theme of this being our best year ever, in 2013 and in the fourth quarter in particular, our stock price soared to its highest level ever bringing our market cap to over $5 billion. So as a consequence of this very great news in terms of the growth in our stock price and our market cap, we are obligated by the accounting rules to mark-to-market the share tracking awards and that results in a inflated value for those awards and inflated expense and hence the GAAP loss whereas the actual Company’s performance is best demonstrated in our opinion by the non-GAAP earnings of over $0.5 billion.
So as you can see in the statement above, it looks like there is a legitimate reason for the high PE ratio. Of course you’ll want to do more of your own due diligence to see if UTHR is the right investment for you. And I’m not recommending it one way or the other.
But this should illustrate the GAAP short comings of stock screeners, right?
And By The Way: If you want to learn a little more about how to analyze stock ideas and find hidden stock market profits I encourage you to download my free eBook below. You’ll get interesting insight and easy to follow tips to help you make smarter stock market decisions.