June 6, 2019

GAAP Accounting Distorts Delphi Automotive’s Economic Reality


Summary

  • Delphi Automotive’s Adjusted Cash Flows From Operations is at $3.8bn, a far cry from as-reported operating cash flows of $2.1bn.
  • One culprit behind this major distortion is the GAAP accounting for goodwill ($656mn), which leads to a significant distortion of the firm’s economic reality.
  • DLPH’s price-to-book ratio is also only at 2.5x once correctly adjusted, versus the traditional 7.9x P/B.
  • Additionally, the firm’s Adjusted Return on Assets is 15%, higher than the 12% ROA level reported by most financial databases.

Performance and Valuation Prime™ Chart

Under Generally Accepted Accounting Principles (GAAP), DLPH’s as-reported financial statements and financial ratios do not reflect economic reality. The traditional ROA computation understates the company’s profitability by incorrectly including certain items. The inclusion of goodwill ($656mn) and non-operating long-term assets ($228mn) inflates DLPH’s total assets, resulting in a distortion of performance measures. Additionally, the firm’s Adjusted Cash Flows from Operations is at $3.8bn, a far cry from as-reported operating cash flows of $2.1bn. The adjustments to operating cash flows are crucial because expensing items like R&D expenses and operating leases, rather than capitalizing them as part of a company’s investments, makes comparing the company to its peers, and even to its own historical performance, impossible. In the case of DLPH, their large R&D expenditures of $1.3bn and operating leases of $112mn lead to a material understatement of the firm’s operating cash flows.

After adjusting for these primary issues and a host of other GAAP-based miscategorizations, Valens calculates DLPH’s Adjusted ROA as 15% in 2015. In contrast, most financial databases show a traditional ROA of only 12%. Additionally, analysis shows that the firm’s Adjusted Forward P/E is at 2.5x, compared to a traditional P/B of 13.2x. Clearly, the profitability of DLPH’s operations and its stock valuation are not what traditional metrics indicate.

The problem with Generally Accepted Accounting Principles (GAAP) is that they create inconsistencies when comparing one company to another, and when comparing a company to itself from year to year. By making adjustments, we aim to remove the financial statement distortions and miscategorizations of GAAP. Some of these can be automated through consistently applied formulas; however, many must be made manually. Manual adjustments that cannot be automated include mergers and acquisitions accounting, special charges, business impairments, and others. The practice of creating consistent, apples-to-apples comparable measures of financial performance is often considered either tedious or overly complex by even seasoned financial analysts.


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