Editor's note: Welcome to "Booyah Breakdown," an explanation of certain terms and topics Jim Cramer discusses on his "Mad Money" TV show. Feel free to
Mind the GAAPInvestors can frequently be tripped up by the GAAP vs. "pro forma" earnings game that companies play. GAAP stands for generally accepted accounting principles. Those are the accounting rules that all companies are expected to follow when calculating their final profit figures. But these rules often require companies to take big hits to their bottom line that many companies argue aren't a true reflection of their day-to-day progress. So management takes them out and comes up with its own version. These are often called "pro forma," "non-GAAP" or "adjusted" results. While these alternative figures can, in fact, be helpful in evaluating a company's true operating performance, investors should note that there are no rules in creating these numbers. Anything that management regards as one-time or irrelevant to the core operations is generally excluded from the pro forma numbers. So don't expect to see restructuring charges or certain types of amortization in there. But be wary of numbers that companies call "one-time" items, but show up quarter after quarter. The silver lining is that there has to be some sort of reconciliation somewhere to explain to you what the difference is between the adjusted and the GAAP number. So you need to go through that carefully and understand what management decided to pull out. While it would be nice if everyone just used the GAAP numbers for conformity's sake, it's at least important that the pro forma number takes out the same items quarter after quarter, says Charles Rotblut, senior market analyst at Zacks Investment Research. Then at least you're comparing apples to apples within the company. If the rules surrounding the pro forma numbers keep changing, it would be way too confusing for investors.
Be a VoyeurGo through these releases carefully. When looking at the earnings per share, determine if it beat, missed or exceeded analysts' expectation. That's the first thing the market's going to react to. Keep in mind, that doesn't mean Wall Street's number was right to begin with, but unfortunately, that's the way it works. Analysts' estimates are usually compiled by a financial firm such as Thomson First Call or Zacks and then averaged. That's how you get the "consensus" or target number that's frequently referenced. Big note: Analysts' estimates typically follow the companies' pro forma or adjusted numbers, so that's usually what you want to compare. That's not always the case though, so make sure to check what the analysts' figures include.
Next, go through the revenue numbers, and also make sure the company is controlling its costs. And pay close attention to the company's "guidance" -- that's code for "here's what we expect to happen in the future." If management is cautious or hints at a slowdown in growth, that will affect the stock. Now keep in mind, an earnings release is usually a single piece of paper, so there's not enough space to tell the whole story. That's why Cramer insists you get on the company's conference call. On the conference call, there's plenty of time to talk about everything -- including that GAAP vs. pro forma stuff -- and sometimes it's just easier to say something out loud than have the legal team attempt to articulate it on paper. So go to the company's Web site. There, you'll either get a number to call in, or you can catch it live on the Web. Either way, listen in. You'll learn more on that call than any analyst's report. That's because you can listen to the tone of the execs, says Rotblut. And just like you can tell if your date is being truthful or being a blowhard, you can do the same as you listen on the call. Granted, only the analysts can ask questions, but you can eavesdrop and gauge the situation at the company on your own. So use all the different facets of earnings season to evaluate your stocks, and make sure the reasons you originally bought the shares still holds true. Only then can you decide if it's worth keeping the relationship going -- or if that Bon Jovi record collection is just a bit too much for you.