Research

GameStop’s As-Reported Financials Distort The Firm’s Economic Reality

Summary

  • GME’s 2015 Adjusted Return on Assets is twice the cost of capital at 13%, higher than the traditional 9% ROA reported by most financial databases.
  • One culprit behind this major distortion is the GAAP accounting for GME’s $2.0bn goodwill, which leads to a significant distortion of the firm’s economic reality.
  • In addition, GME’s Adjusted Cash from Operations is $980mn versus the firm’s as-reported cash flow from operations of only $632mn.

Performance and Valuation Prime™ Chart

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.

Under GAAP, the as-reported financial statements and financial ratios of GME do not reflect economic reality. The traditional ROA computation understates the company’s profitability by incorrectly including certain items. The distortion of both profitability measures and valuation metrics are driven by the inclusion of goodwill ($2.0bn) which inflates the company’s assets, and the incorrect expensing of operating leases ($304mn) which deflates the company’s earnings.

After adjusting for these issues and a host of other GAAP-based miscategorizations, Valens calculates GME’s Adjusted Return on Assets as 13% in 2015. In contrast, most financial databases show a traditional ROA of only 9%. The profitability of GME’s operations is therefore not what traditional metrics suggest.


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