Information is All Around You, But Can You See It?

Recently, I was exchanging emails with the man who gave me my start as an investment analyst three decades ago. That firm Equity Research Associates, was a vibrant, sassy upstart that was known for first-rate, highly original, forward-thinking research. I learned from him that investment success is about figuring out what’s going to happen next not what happened last week or last month. Success demands that you figure out trends before they are well observed. There are huge rewards for being early to the party and gigantic penalties for being the last one to leave.

 
It’s Hard to Protect Against Massive Fraud
Look at all the articles about Enron now. Who cares? It is too late. The money is down the drain. There isn’t much difference between Enron, Linda Wachner at Warnaco, or Chainsaw Al at Sunbeam. None of them cared about shareholders. Aggressive accounting is aggressive accounting.
 
Too much debt is too much debt. Cooking the books is cooking the books. When a massive fraud is being perpetrated on many levels of a corporation such as occurred at Enron, it is hard to protect yourself unless you read the statements yourself and have the skills necessary to look for oddities in the footnotes. The shortsellers detected that something was wrong by reading those statements. Frauds of this scale and scope don’t happen all that often but when they do, a lot of people are duped. This fraud was just a little more brazen than most because the “perps” bought themselves an awful lot of political influence all over Texas and stretching right on into the Cabinet, the Bush White House and the Congress. That is why there is massive spin-doctoring going on in Washington right now. 
 
Warnaco flashed warning signs for years
Eight years ago, I visited Warnaco. Before I did, I thoroughly reviewed the financial statements including its SEC filings. Mrs. Wachner was paying herself an absurdly high salary for the size of the company. Earnings were being inflated by aggressive assumptions about the expected investment performance of the company’s pension plan. By assuming very high investment returns, management avoided making annual contributions to its pension plan that would have resulted in a charge against earnings. With this trick, Warnaco was able to inflate its reported results, gain a higher p/e multiple from investors and, thus, a higher stock price. This gimmick was a red alert that the company was being run to line Mrs. Wachner’s pockets and not for the best interests of shareholders. She kept me waiting for an hour and then decided she didn’t have time to see me at all. I never went near the stock. I already knew all I needed to know. It was only a matter of time until the Warnaco jig was up.
 
Clues Can be Anywhere
In December 2001, I stopped in at Radio Shack to buy some batteries. The company was offering a most unusual promotion that I found bizarre. Essentially it was a “buy one, get one free” offer with a very odd twist. Pay in December and get the free batteries in January, a different measurement period. They were hoping you would lose your receipt or forget to come back. What I processed through my head was “the quarter must be poor.” Sure enough, the company reported disappointing sales results just a few days later and the stock dropped. My powers of observation in my everyday life were all that I needed to come to the right investment conclusion. A good investment manager doesn’t work 9 to 5. They never stop working!
 
AOL Time Warner
We applied the same common sense to AOL in the fourth quarter, 2001. Management kept insisting that business was fine and the company would meet the very aggressive goals it set for itself at the time of its massive merger with Time Warner a year ago despite a very punk advertising environment. Simultaneously, it kept announcing serial lay-offs. Something just didn’t compute so we sold our shares at 39. The rest is history. Billion dollar write-offs, more lay-offs, a major management shuffle and disappointing results were announced for the fourth quarter. The stock is now ten points lower even as the markets overall are higher. 
 
The moral to the story 
Use common sense. Pay attention to the clues around you. Don’t neglect a review of the financial statements. They are available from the SEC on the internet at its EDGAR on-line service at no charge. If it is beyond your skill set, make sure the person managing your money is reading them for you with a trained eye. I earned an M.B.A. in financial accounting at New York University and have always regarded it as my secret weapon in the Wall Street wars. The rigorous Chartered Financial Analyst  program stresses at least minimal accounting skills. Look for similar training in your investment advisor. He or she will have a CFA after their name on their business card.  Remember that charts are nice but, in the end, fundamentals always drive stock prices. The more you can figure out before the pack, the happier your investment results will be. You won’t be the last one at the party after all the air is out of the balloons.

 

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