Economic Versus Accounting Earnings


Economic earnings represent the true earnings for shareholders and are very different from accounting earnings. GAAP accounting data was not originally designed for equity investors, but for debt investors.

To derive economic earnings, 30+ adjustments must be made to accounting earnings. These adjustments remove items hidden in the footnotes and MD&A of annual filings and close loopholes within GAAP accounting.

The formulae for economic earnings are in Figure 1.

Figure 1: How To Calculate Economic Earnings

NOPAT – WACC * Invested Capital


(ROIC – WACC) * Invested Capital

Sources: New Constructs, LLC and company filings

Economic earnings are better than accounting earnings because

  1. They are based on the complete set of financial information available
  2. They are normalized for all companies
  3. They are a more accurate representation of the true underlying cash flows of business.

If a company is not generating positive economic earnings, it is not creating shareholder value. Figure 2 shows which companies are creating and destroying the most value.

Figure 2: Companies With Highest/Lowest Economic Earnings


Sources:  New Constructs, LLC and company filings.

Out of 3000+ companies, Apple (AAPL) earns the largest economic earnings at over $51 billion. See Apple’s historical economic earnings dating back to 1998 here. Apple has earned positive economic earnings every year dating back to 2004. Gilead Sciences (GILD), Microsoft Corporation (MSFT), China Mobile Limited (CHL), and Alphabet (GOOGL) each generate some of the highest economic earnings of all companies under coverage. In order to be as transparent as possible, we provide a reconciliation of GAAP net income to economic earnings in each of our company models. Investors only stand to benefit from increased transparency, which is why our calculations are made available in each company model. The reconciliation of Gilead’s GAAP net income to economic earnings can be found here.

Entergy Corporation (ETR) generates the lowest, or most negative economic earnings of all companies under coverage. See Entergy’s historical economic earnings dating back to 1998 in our model here. As can be seen in our model, Entergy has failed to generate positive economic earnings in any year of our model. The company has consistently increased its invested capital while not generating a subsequent increase in profits, thereby destroying shareholder value in the process. See the reconciliation of GAAP net income to economic earnings here. Citigroup (C), Deutsche Bank (DB), Lloyds Banking Group (LYG), and Chevron Corporation (CVX) round out the top five companies with the lowest economic earnings.

Our models and calculations are 100% transparent because we want our clients to know how much work we do to ensure we give them the best earnings quality and valuation models in the business.

Want to apply these concepts and more?

Get free access to more research. Check out the free Education center where we explain all the theory and concepts behind what we do. Take a Virtual Tour to see how our services work.

How To Use Accounting Data (Accounting 101)

Accounting data must be translated, through rigorous analysis of the footnotes and the MD&A, into economic earnings in order to understand the profitability and valuation relevant to equity investors. More details are in Finance 101.

Why Economic Earnings Are Better

Respected investors (e.g. Adam Smith, Warren Buffet and Ben Graham) have repeatedly emphasized that accounting results should not be used to value stocks. Economic earnings are what matter because they are:

  1. Based on the complete set of financial information available
  2. Standard for all companies
  3. A more accurate representation of the true underlying cash flows of the business

Therefore, the economic model based on all relevant financial information is required to asses the economic earnings of companies.

Numerous academic studies and loads of empirical evidence also also support the merits of economic earnings. The prior links are just a few samples. You can find much more by doing a quick internet search on accounting loopholes, accounting tricks, etc. There are many excellent books, a few are listed below, that delve deeply into this topic as well.

  1. Valuation: Measuring and Managing the Value of Companies by McKinsey and Co.
  2. Creating Shareholder Value by Alfred Rappaport
  3. The Quest For Value by Bennett Stewart
  4. Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports by Howard Schilit.

Challenges In Deriving Economic Earnings

In addition to gaining expertise in accounting rules and economic theory, gathering all the relevant data to build a comprehensive economic model is quite time consuming and difficult. Our patented sys­tem and pro­pri­etary tech­nol­ogy enabled us to build a Research Plat­form that, for the first time, allows investors to rely on a com­pre­hen­sive eco­nomic model when mak­ing invest­ment deci­sions. No longer must investors rely on the account­ing data that Cor­po­rate Amer­ica and Wall Street pub­lish. Now, investors have, via New Con­structs, an alter­na­tive source of unbi­ased, com­plete infor­ma­tion on the economic prof­itabil­ity and val­u­a­tion of companies.

**Deriv­ing eco­nomic earn­ings from account­ing data is a dif­fi­cult and time-consuming task, pri­mar­ily because it requires ana­lyz­ing and extract­ing crit­i­cal infor­ma­tion from the Finan­cial Foot­notes. The Help Sec­tion of New Con­structs web­site walks you through ever step of the process. The first step is to cre­ate eco­nomic finan­cial state­ments, which are com­prised of:

  1. NOPAT (Net Oper­at­ing Profit After Tax)
  2. Invested Cap­i­tal cal­cu­la­tion and definition
  3. WACC (Weighted-Average Cost of Capital)

Once you have your eco­nomic finan­cial state­ments, then you can derive the eco­nomic value dri­vers that we use to mea­sure the true, under­ly­ing prof­itabil­ity of companies.

  1. ROIC (ROIC stands for Return on Invested Capital)
  2. Eco­nomic Profit/earnings (note EVA is same as Eco­nomic Profit)
  3. Free Cash Flow
  4. NOPAT Mar­gin
  5. Invested Cap­i­tal Turns

See our webinar on importance of ROIC and how to calculate it.

Here is our report on “ROIC: The Paradigm For Linking Corporate Performance to Valuation.


  • Johnson

    May 6, 2015

    Dear David,

    An amazing read. What is the success rate of using economic earnings analysis on stocks? How does it compare to other methods?

    Thank you.


  • Andre Rouillard

    May 7, 2015

    Thanks for reading and commenting. I encourage you to check out this post, particularly Figure 1:

    Figure 1 in the above post shows that the economic earnings margin (return on invested capital (ROIC) minus WACC) explains 67% of the difference in valuation between companies in the S&P 500.

    In addition, we use economic earnings to put together our monthly Most Attractive stocks list, which has generated annualized returns of 10% since its inception (compared to 6.6% for the S&P 500 and Russell 2000). You can find more info on our performance here:

    Thanks again, and feel free to email us at with any additional questions!

    – André Rouillard, Investment Analyst

  • vinay

    August 24, 2015

    Alike the economic earnings and financial earnings…is there a difference between economic information and financial information? because in one of the definition of accounting by American accounting association…Accounting is the process of identifying measuring and communicating the ECONOMIC INFORMATION ……. It does not say financial/accounting information. Can you please throw more light on this.

  • David Trainer

    September 27, 2015

    Very big difference between accounting and economic information:
    This white paper provides all the details:

Leave A Response

* Denotes Required Field