On behalf of RSM, Prof. Marco Mongiello, Executive Director MBA and MSc Programmes at Surrey Business School, talks with Ken Lee, Head of European Equity Research at Barclays, and Deborah Taylor, Senior Analyst in Accounting and Governance Research at Barclays.
The role of Alternative Performance Measures (APMs) is widely discussed among accountants, analysts, investors, as well as standard-setters as it is right at the heart of the concept of informational value of accounting.
To contribute to this debate, we have reached out to Barclays Equity Research and asked how they use APMs in their work when providing insight for investors.
Deborah Taylor (DT) makes it clear from the start that APMs are very relevant to analysts, pointing at page 2 of a research note that a Barclays’ sector team had recently produced on Rolls Royce: “you can see how significant the APMs are for us. This particular company in aerospace and defence has not one single GAAP measure; they are all adjusted.”
DT: “I would say that across all sectors the vast majority of ‘page 2 measures’ [APMs] are adjusted. This is not to say that the GAAP measures are not relevant to us. It is just that the headline numbers we refer to are adjusted in some way.”
RSM: “What about the comparability of these measures? And how can investors rely on these measures?”
DT: “I see three types of measures: GAAP numbers, Corporate adjusted numbers and Analysts’ adjusted numbers.
The last category exists because we do not always have full confidence in how companies have arrived at their adjusted measures. However, when we make our own adjustments, investors wonder where those numbers come from, as they do not match the numbers that were presented by the company and to which everyone else refers.
It is so important to investors that there is coherence across all the numbers produced by the companies and perhaps other analysts. In a sense, we have to come back to the companies’ definitions; we are tied to what the company is presenting, even if we do not like it. We need to look carefully at how the companies form these numbers. That is not to say that we take them in blind faith. As analysts we do make additional adjustments or reverse out some of the adjustments that the company has made, to get to a more reliable measure to predict future earnings.”
Ken Lee (KL): “The reason why the company’s version normally wins is that often the detail you will need to calculate that number is not available to the analysts. Furthermore, one must remember that analysts consume the accounts primarily reading the preliminary announcements, rather than when the end of year accounts are published. As accountants we would think it is the annual report which provides the most relevant information. Instead, many analysts refer only to the preliminary announcements, where the information that is available is even more limited than in the annual report.”
RSM: “So, is the annual report used only for historical analysis?”
DT: “The way some teams use the annual report is for long-term thematic research. So, for example, our banks’ team may do a deep dive analysis on the quality of the loan book, based on the disclosure they find in the annual report.”
KL: “Also, if analysts were using the annual report they would find it impractical to read the 400 pages it can be made of. But that is not the way they actually use the annual report. In fact, if a team of analysts are making a loan analysis of a bank, it can take weeks and weeks to complete it. They quite like to see so much disclosure, because they have got some time. The rush to evaluate the performance of the business does not happen at the annual report issue stage. Although in the sectors, as for example food retail, and oil and gas, we have teams that produce research based on annual reports, they are a small part of our operations.”
DT: “…and they identify themselves as being very technical in terms of their analysis.”
RSM: “How do you cope with the APMs’ departure from comparability, as we know it in accounting?”
KL: “In general the deeper you go the less comparable it gets. It depends on how deep you go and the sectors. First of all there are sectors with a wide internal variety, like the service sector. In other sectors, though, businesses are much more similar, e.g. large companies like food producers, and giving a more detailed analysis will not compromise the comparability.”
DT: “Our analysts spend a bit of time to make sure that within their sector they make similar adjustments, ensuring that everyone is on a level playing field. Still there is variability in some sectors more than others.
A classic example is aerospace and defence, where you get a lot of different ways of adjusting for currency, for pensions, amortisation of intangibles. Again in the media sector, you come across restructuring costs presented below the line and above the line by different companies. So, analysts are quite careful in making sure they are looking at every company in a comparable way. But they also have to go back to the company’s definitions of adjusted measures, because these are the numbers that people know.”
RSM: “Other sectors are much more innovative. Some companies are so innovative that we may find it hard to classify them in one or another sector. For example, Tesla Motors and Uber are so innovative that you cannot evaluate their performance based only on their accounts. Are APMs of more use in these contexts?”
DT: “I think APMs are used across all sectors. Whether they are more widely used in the more innovative sectors is difficult to conclude. One of the issues we have is that in general when you look at younger companies they tend to use APMs more. Younger companies may feel they are more tied to their performance targets and they are keen to show how they are meeting them. Also, more mature companies, may have stronger corporate governance and be less aggressive in the way they adjust their performance measures. It is hard to distinguish between ‘innovative’ and ‘young’ companies and how they use APMs in their reports.”
RSM: “Are you saying that the variable is the degree of corporate governance, i.e. companies which display less corporate governance rely more on APMs to provide reassurance about their ability to perform?”
DT: “Corporate governance is a variable, yes.”
KL: “For example in the transport sector, Uber and Stagecoach in Europe or Greyhound Lines in the US are almost impossible to compare. You would have to find a unique approach for very young companies, where there is no earning and it is all about growth. This comes through in valuation metrics more than accounting. Accounting will reveal isolated aspects of their performance, but again accounting cannot keep up with the level of short term milestones that are needed in these companies, e.g. quarterly growth targets. So you can switch away from accounting and use sales growth and other measures but you do not really have an alternative, as the company is not making any money.”
DT: “More mature companies are also more likely to have been engaged in M&A. They may have legacy pension issues, for example, or other things that may cause certain companies to make adjustments to focus on their core performance. So, we cannot make the swift conclusion that innovative companies are more likely to use APMs.”
RSM: “Should IFRS encompass the additional information required by investors to better understand highly innovative companies?”
DT: “I think it is very hard to identify this as an IFRS responsibility. The issue is that there really is not a very close dialogue between the IASB, the regulators and investors. Ideally, there should be a forum aimed at reaching a reasonable position, where everyone contributes to make these APMs as reliable as possible. We do not necessarily want everyone to use exactly the same definition; there always has to be flexibility, but there needs to be some framework in place for companies when they report this type of information. Every attempt to improve has been done by one element [IASB, regulators or investors] independently. Some initiatives have indeed taken place, but the results are yet to be apparent.
Investors are split: some investors prefer companies to be left to do what they want in terms of APMs; other investors think that it is absolutely outrageous, companies should not be allowed to publish non-GAAP measures. As ever, when you involve investors you get a wide range of opinions.”
KL: “The level of expertise one needs to give a sensible suggestion as to whether IFRS should include APMs is well above that of most investors. This does not mean that they would not welcome some changes. They just do not know what alternatives are on the table. For example in the debate of impairment versus amortisation, investors have a limited understanding of the terms of the matter and, besides, they use preliminary announcements more than the final accounts anyway.”
In conclusion, APMs are indeed relevant for the analysts who, in turn, support investors’ decisions and claim a significant role in providing complementary information in the analysis of companies’ performance. This, for preparers, is an additional reason for reflecting on both the importance of clarity in the explanation of the adjustments they make, when they produce APMs, and how the accounting information they produce will be used by analysts and investors to produce further APMs, given that the end goal remains unchanged, i.e. to provide the users of the accounts with the information that best supports their decision making.
Deborah Taylor is a senior analyst at Barclays Equity Research where she specialises in Accounting & Governance research. Deborah joined Barclays in 2009, having previously worked as an analyst at Citigroup. Prior to that, Deborah was as an auditor at Deloitte, where she trained as a chartered accountant.
Kenneth Lee is a Managing Director, Head of Equity Research, Europe & Head of Accounting & Valuation research at Barclays. Mr. Lee joined Barclays in 2009. Prior to this he was a Managing Director at Citi Investment Research where he was on the Research Management team and a top two ranked accounting and valuation analyst. Previously he was a professional trainer on valuation in the City and, prior to that, an accountant and tax consultant with Arthur Andersen in Dublin. He has authored 'Accounting for Investment Analysts: an international perspective' (BG publishing) and co-authored 'Company valuation under IFRS' (Harriman House). Mr. Lee is a fellow of the Institute of Chartered Accountants in Ireland, a member of the Securities Institute, an associate of the Institute of Taxation in Ireland and a CFA charterholder.