AnalysisHow dual-listed companies boost profits without earning more
Analysis
How dual-listed companies boost profits without earning more
The creative accounting tricks Israeli firms use to inflate earnings.
Most dual-listed stocks, which are traded both on the Tel Aviv Stock Exchange and on other exchanges, mainly in the U.S. and London, adjust their profit margins in ways that benefit them, enhance their profitability, and make it challenging for investors to accurately price them and forecast profits. Notably, ten of the 35 stocks in the Tel Aviv-35 Index are dual-listed, traded both in Tel Aviv and on U.S. stock exchanges, with another stock in the index also traded on the London Stock Exchange.
The reporting of dual-listed companies that are also traded in the U.S. follows GAAP—reports prepared according to American accounting standards (Generally Accepted Accounting Principles). However, most of these companies also release adjusted profit reports (non-GAAP), which present their current profitability while omitting one-time or accounting-related components. This approach reflects management’s belief that such components may mislead investors when assessing current profitability.
At first glance, investors might think they should rely primarily on adjusted reports to assess a company’s value. These reports neutralize one-time effects or impacts from accounting rules, making adjusted profit appear to better reflect future profitability, the primary factor influencing a company's current share price.
In all Israeli dual-listed companies included in the TA-35 Index that publish adjusted reports, the adjusted net profit has consistently been higher than the GAAP profit since the beginning of the year. This pattern has persisted in most previous years as well. Consequently, investors who rely uncritically on adjusted reports may overestimate a company’s actual profitability.
The main reason adjusted profits are significantly higher than accounting profits lies in the exclusion of many expenses recognized in GAAP reports but omitted in adjusted ones. This goes beyond omitting extraordinary income from GAAP reports and creates an asymmetry in favor of adjusted profits. Investors who aim to calculate a company’s current profitability must adjust the adjusted reports to correct the bias caused by this persistent gap.
In many companies, part of employee compensation is issued through stock options, rights to future shares, or benefits tied to future share prices. GAAP accounting recognizes these share-based payments as an expense. While this expense does not affect cash flow, it generates positive cash flow when the options are exercised. However, share-based payments increase the number of outstanding shares, diluting the holdings of existing investors. Therefore, investors assessing a company's future profitability should account for these expenses. Excluding such expenses could lead to misleading conclusions. If a company avoided share-based payments, it would likely need to increase cash compensation for employees.
Share-based payments are particularly significant in Israeli technology firms. For instance, NICE recognized a $138 million expense for share-based payments in the first three quarters of the year in its GAAP reports, an expense omitted from its adjusted reports. NICE’s adjusted operating profit during this period was $622.4 million, with share-based payments accounting for 22% of that figure. NICE's GAAP operating profit, however, was $391.6 million. The primary difference between the two stems from share-based payments and a $90 million write-down of acquired intangible assets, a topic discussed later.
NICE projected its adjusted net profit for the year to range between $695 million and $707 million, while its GAAP net profit was expected to be between $450 million and $460 million. With a market capitalization of $11.6 billion, NICE trades at a price-to-earnings (P/E) ratio of 16.5 based on adjusted profit and 25 based on GAAP net profit. NICE also holds $1.07 billion in excess financial assets. Despite its continued growth in data-driven cloud computing for customer service, the market is concerned about a potential slowdown in growth, as indicated in its third-quarter reports. When pricing NICE shares, investors should factor in share-based payments as expenses, increasing its adjusted P/E ratio from 16.5 to 20.
The same principle applies to other major Israeli companies like Ormat, Nova, Camtek, and Tower, which make up a significant portion of the TA-35 Index and whose total weight in the index is approximately 12%. Share-based payments account for more than 10% of these companies’ operating profits. For instance, Nova recorded a GAAP profit of $133.3 million and an adjusted profit of $152.6 million in the first three quarters of the year. Most of the gap stemmed from share-based payments. Nova’s adjusted profit forecast for the year ranges between $207 million and $214 million, with its $5.6 billion market value reflecting a P/E ratio of 26.5 based on adjusted profit and 31 based on GAAP profit.
Camtek’s GAAP profit for the first three quarters was $85.5 million, compared to $100.9 million in adjusted profit. Its adjusted profit forecast for the year is $140 million. Trading at a value of $3.5 billion, Camtek’s P/E ratio is 25 based on adjusted profit and 29.5 based on GAAP profit. Camtek holds $488 million in surplus financial assets and is expected to continue profit growth in 2025.
Tower emphasizes its GAAP reports, relegating adjusted figures to the bottom. Tower’s January-September GAAP profit was $152.7 million, compared to $174.6 million in adjusted profit, with the entire gap attributed to share-based payments. Tower’s adjusted profit forecast is $245 million, and its $5.4 billion market cap reflects a P/E ratio of 21.5 based on adjusted profit and 24.5 based on GAAP profit. Unlike other years, Tower’s GAAP profit in 2023 exceeded adjusted profit due to compensation received from Intel for canceling the Tower acquisition deal—a factor not included in adjusted reports.
Acquisitions of intangible assets often introduce asymmetry. Successful acquisitions boost adjusted profits, while losses from failed acquisitions, such as goodwill impairments, are excluded. For example, Teva neutralized goodwill write-offs and intangible asset amortizations worth billions in adjusted reports, resulting in a biased view of profitability.
Legal costs and other provisions excluded from adjusted reports also bias profit figures upward. For instance, Teva’s $638 million provision for legal claims this year was excluded from its adjusted reports. Provisions like these, alongside restructuring costs and other expenses, occur periodically and further skew adjusted profit figures.
Investors must critically assess adjusted reports. When significant gaps persist between adjusted and GAAP profits, adjustments are necessary to accurately reflect current profitability while accounting for the future outlook of excluded items.
Uri Tal Tenne is an economist at an Israel-based tech company.
