Generally Accepted Accounting Principles ("GAAP") are a set of accounting principles, procedures, and standards issued by the Financial Accounting Standards Board (FASB). GAAP aims to improve the comparability, consistency, and clarity of the communication of financial information. While GAAP is used in the U.S., the international equivalent, it referred to as International Financial Reporting Standards ("IFRS").
How can I use GAAP when I invest in stocks?
- As GAAP ensures that a company's financial statements are complete, consistent and comparable, it makes it easier for you to analyse and extract useful information data from the company's financial statements. This helps you to make a more accurate and informed decision to pursue an investment venture.
- However, GAAP has its limitations too. Firstly, GAAP is only recognised in the U.S. and not the global standard for preparing financial reports. Suppose you want to compare two stocks from the same industry but from different countries (one being the U.S.). In that case, it gets harder to make a fair comparison as these two companies use other financial reporting metrics. Furthermore, GAAP tends to take a "one-size-fits-all" approach rather than account for the immense diversity often seen between different companies. Thus, smaller businesses that may struggle to incorporate all the GAAP principles may be seen as a weaker investment option than it is.
- While GAAP is the U.S. standard for publicly listed companies, some private companies filing for an IPO (going public) might be tempted to use non-GAAP reporting in their prospectus. An example would be WeWork, which used "community-adjusted EBITDA" for its IPO prospectus, and which subsequently drew significant criticism from the media and potential investors, resulting in the shelving of its IPO plans.
Debt to Equity Ratio
Used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.
Profit is the financial benefit realized when revenue from a business is higher than the costs and taxes involved in operating that business.
Alternative investment class composed of funds that invest directly in private companies or that buy public companies and take them private
Time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales.
A stimulus package is a coordinated effort by the government to increase spending and investment to "stimulate" an economy out of a downturn.
Shorting a stock
Trading strategy that tries to take advantage of the decline in a stock price by borrowing a stock and sell it now while planning to repurchase it later for a lower price.
Market-capitalization-weighted index tracking the performance of the 500 largest U.S. companies