What the day traders are up to...

Certainly an alternative investment strategy to trying to identify good businesses that are undervalued, then buying and holding!

From the Sydney Morning Herald.

They are the new breed of derivatives traders: they have no clients, they trade their firm's own money using high-powered computer programs like F1 - Formula One, so-called because it is so fast - based on secret algorithms.

US sharemarket officials and Congress are mulling bans on some of their tricks. And it is so profitable, the big banks are using it. The New York Times and The Wall Street Journal have devoted pages to the dark arts of ''high-intensity'' and ''low-latency'' trading and the world of ''dark pools''.

Credit ratings agencies still under fire for their role in the GFC. Here's the Herald with the latest thoughts.

The essential conflict many of these agencies face is described here:

Critics want the cosy club inhabited by the three big credit ratings agencies to be replaced by a system with more accountability to investors, and less crippling conflicts of interest.

So what can be done to fix the credit rating agencies, seen by many as the unsung villains of the crisis?

Some suggestions include holding the firms responsible for their opinions in the courts, breaking up the oligopoly, and cutting investors' reliance on ratings. None is foolproof but each attempts to address the conflict of interest that was brutally exposed by the credit crisis.

A credit rating from one of the big three firms is virtually indispensable for companies looking to raise debt on the market. But it is now clear the incentives in the current system were skewed to encourage agencies to provide as many ratings as possible, at the expense of good advice.

For decades issuers have paid for the ratings because they need them most, and it has been in the agencies' interest to approve as many ratings as possible. However, the Bank for International Settlements says growth in structured finance - complex bundles of corporate debt - created huge systemic risks for this arrangement.

Explaining your accounts

I have mentioned in class that companies can use voluntary disclosure to explain how the accounting rules impact on their results, and also that we have seen examples of this with the adoption of A-IFRS accounting standards in Australia.

Here's one example - Westpac provided this presentation in April 2007 (note - link to pdf file).

How banks can manage earnings

No surprises, it's the loan-loss reserve. Businessweek with more details.

Inept boards - Krispy Kreme

From the New York Times (2005). Posted as KK is one of the case studies. Also shows the problems of rapid growth and franchising.

Security analysts & insider trading

The better the job you do as an analyst, the closer you get to insider trading. Apparently. An old (2005) New York Times article about the drug approval process and the work of security analysts

Stock options

From a few years back, how companies were trying to 'ignore' the requirement to expense stock options. This one was about the stressing of "pro forma" results, i.e. excluding the impact of expensing options. From the New York Times in 2005.

And a bit of background from the year before in Forbes focusing on Silicon Valley. Why hi-tech? Well that's where a large number of companies were paying large proportions of salaries as options.

Xerox and lease accounting

Here's an old one from the New York Times (by old, I mean from 2002) about Xerox's battles with the SEC over lease accounting.

And an even older one (from 2000) in Forbes about nonrecurring items that turn out to be, well, recurring.

Steven Mayne on the recent earnings results

In the Herald.

ASIC takes action against

After a long time during which ASIC has been accused of being too lenient on enforcement issues, action is taken against auditors involved in a corporate collapse.

THREE partners of accountancy giant KPMG have been banned from acting as auditors for periods of up to two years over their involvement in the $390 million collapse of the Westpoint property empire.

Leases and valuation

We were speaking this week in class about adjusting for accounting distortions. Here's a link to a recent article about capitalising operating leases by Aswath Damodaran from New York University. It's in the Journal of Applied Research in Accounting and Finance (JARAF), Vol. 4, No. 1, pp. 3-29, 2009

Here's the abstract:

When analyzing or the value of a firm, there are three basic questions that we need to address: How much is the firm generating as earnings? How much capital has been invested in its existing investments? How much has the firm borrowed? In answering these questions, we depend upon accounting assessments of earnings, book capital and debt. We assume that the reported operating income is prior to any financing expenses and that all debt utilized by the firm is treated as such on the balance sheet. While this assumption, for the most part, is well founded, there is a significant exception. When a firm leases an asset, the accounting treatment of the expense depends upon whether it is categorized as an operating or a capital lease. Operating lease payments are treated as part of operating expenses, but we will argue that they are really financing expenses. Consequently, the stated operating income, capital, profitability and cash flow measures for firms with operating leases have to be adjusted when operating lease expenses get categorized as financing expenses. This can have far reaching implications for profitability, financial leverage and assessed value at firms.

Some old accounting analysis / earnings qaulity articles

Here's one by Gretchen Morgenson in the New York Times about how to spot and undo questionable accounting.

Also an old Businessweek cover story back from 2004 - Fuzzy Numbers.

News Corp - underlying economics or big bath?

News Corporation recently announced its full year 2008-09 earnings, and they included large write-downs. By large, we mean just under $US9 billion. Now we'd expect large write-downs given the impact of the "Global Financial Crisis"; but now would be a good time to take an aggressive approach to write-downs. Here's how The Australian (owned by News Corporation) reported the results. Here's the New York Times take on it. Here's the conference call transcript News held with analysts and investors.

* Photo by Flickr user oh_simone. Original photo here.

Security analysts & incentives

Not surprisingly, there still seems to be some pressure on (sell-side) security analysts to provide an optimistic outlook. Here's Andrew Main (City Beat) on analyst Brett Le Mesurier leaving the industry.

Le Mesurier's form includes being the first analyst to have put a sell on Babcock & Brown -- "not early enough" as he ruefully put it yesterday.

He's got a reputation for calling things as he sees them, which may not be an instant hit with the big corporate brokers. Take his view on NAB: "It's the worst-performing bank, and they've consistently delivered in that department."

He admitted such lines don't make him instant friends on the sell side.

"But the fund managers love it."

Australian retailing

How successfully implementing your strategy can benefit your competitors.

Matthew Stevens in The Australian:

SOMETIME before Christmas Bernie Brookes and his fellow owners of Myer Group could be given 1.5 billion reasons to thank Mark McInnes for being such a fine retailer.

This might seem a strange proposition, given that McInnes runs David Jones and is the bloke lauded for the impressive restoration of the brand and balance sheet of Australia's up-market department store operator.

* Photo from Flickr user Voice Pictures. Original photo here.

Australian business podcasts / vodcasts

ABC radio's Radio National provides access to a number of business-related podcasts that might be useful if you wish to know more about the business environment in Australia. You can subscribe to the business podcast at the link.

You'll also find vodcasts from groups like Macquarie Bank.

Here's another one, bnet Australia with a marketing focus, but still providing some strategy-related materials. You can apparently subscribe to their podcasts on itunes.

Beijing restaurants (& Sydney restaurants)

I have a friend who is off to Beijing next week for a week. If anyone has any tips for good eating (not western food) there, it would be great if you could let me know. [I also want good eating tips for when I next visit Beijing].

Here are my tips for "best value lunches in Sydney" (not cheapest, but best value).
1. Marque Go for the Friday lunch. Review (about as good a review as you'll find) in the Sydney Morning Herald here.

2. Restaurant Balzac - closer to uni, and $5 more than Marque, but a good value Friday lunch.

UPDATE: In case $50 is a bit too much for a meal, here are some cheaper, but still very tasty restaurants in Sydney.

1. Spice I Am - go to the Surry Hills one, not the Darlinghurst one. Good cheap, spicy Thai food. No decor.

2. Kiroran Silk Road Uigher Restaurant - Dixon Street, Chinatown. Ridiculously cheap Xinjiang restaurant.

3. Mamak - Chinatown. Great cheap Malaysian. Best roti in town.

4. Maya Masala - good cheap vegetarian Indian restaurant on Cleveland Street, Surry Hills.

Note: I've been advised that the restaurant in the photo above is:
Shun Xin Zhai Beijing Noodle Restaurant 顺心宅老北京炸酱面
Address: No. 40, Shuiyuan Wuchang, Huajiadi, Chaoyang District, Beijing, China
朝阳区花家地小区水源五厂40号(方舟苑小区对面)
I've eaten there and it's great!

Fair value accounting

Well we're into the reporting season. One of the things I have previously suggested we look out for is the impact of "mark-to-market" accounting; especially for businesses that have a relatively large amount of investments in listed assets.

Last night Lateline Business ABC television interviewed the Managing Director of Australian Foundation Investment Company (AFIC), who announced a 75 percent fall in full year profit. The Australian Foundation Investment Company (AFIC) says the slump, to $103 million, reflects a big fall in realised gains and a more than $100 million impairment charge. Transcript and video here.

UPDATE: Not suprisingly, AFIC is calling for an overhaul in the accounting rules for 'impaired' assets. From The Australian:

"The (accounting) standard doesn't make a lot of sense for us," AFIC managing director Ross Barker said. "We have $1 billion in our revaluation reserve, but we can't offset any of that against the assets that we are holding below-cost."

AFIC, he said, was making its views known to international and domestic bodies that review and create accounting standards.

An exposure draft where mark-to-market gains and losses would all be taken through the profit and loss statement, or the balance sheet, would not help, according to the AFIC chief.

The first option would create volatile earnings streams, while the second would mean the dividends that AFIC earns from its investments would also have to be taken through the balance-sheet as an adjustment to reserves.

UPDATE: Here's Argo, another listed investment company, with a similar tale.

Managing director Rob Patterson said the $64.4m loss after tax was not the best measure of the company's performance over the financial year, as it did not reflect the income received from the investment portfolio and was inconsistent with the company's long-term investment philosophy.

A more accurate indicator, he said, was the operating profit of $163.4m, which was down 10.4 per cent from the previous financial year.

The return on the company's investment portfolio over the financial year was a loss of 16.8 per cent, outperforming the benchmark All Ordinaries Index, which declined by 22.1 per cent.

How accounting rules can affect business strategy

The change to 'mark to market' accounting for certain asset classes continues to impact on the business environment. Today, Adele Ferguson shows us the impact on some of the Macquarie Group listed vehicles.

The demise of Babcock & Brown, Allco Finance Group and the unravelling of the complex structures behind the Macquarie satellites are a stark reminder that investors have had a gutful of backing a model that was good for the head stock/external manager and bad for investors.
...
A statement from ASIC late last month on "fair values", no doubt speeded up the model's demise. ASIC said "careful consideration should be given to whether assets are traded in active markets. Most ASX-listed securities are actively traded, in which case, quoted prices should be used".

This would have given the Macquarie boys some major heartburn. In its latest results, released in May, profit was down 52 per cent, as chief executive Nicholas Moore made a $2.5 billion writedown on assets such as MIG, MAP, BrisConnections, real estate equity investments, loan impairment provisions and CDO exposures.

Keep an eye out in the upcoming reporting season for the impact of mark-to-market driving write-downs and hits to earnings.

The ongoing debt problem

According to Adele Ferguson in The Australian,

CORPORATE Australia is sitting on a $200 billion debt bomb that needs to be refinanced over the next three years, with analysts warning some infrastructure and small companies will collapse under the mountain of debt.

What to expect in the reporting season

ANALYSTS believe the August full-year profit reporting season will mark the low point of the earnings rout, suggesting now could be the right time to start looking at cyclical stocks again. As companies prepare for what is tipped to be the worst reporting season in 20 years, most equity strategist are forecasting that earnings will hold up in fiscal 2010. For the 1510 listed companies with a June 30 balance date -- 72 per cent of all the companies listed on the Australian Securities Exchange -- reporting season has already begun and will conclude on August 28. Almost all of the companies will post their full-year reports during August.

From The Australian

Competition in retailing

Following on from the earlier post about the entry of Costco, here's John Durie in his Martin Collins column in The Australian talking about the currents goings on.

John filed his column before Woolworths announced its full year sales figures. Up 7.5% to just under $50billion.

Toxic assets & increased transparency

Kenneth Scott and John Taylor argue in the WSJ that mandated disclosure is needed to help address the (still ongoing) issue of getting so-called "toxic assets" off bank balance sheets.

It's a(nother) good little summary of (part of) the problem, and how regulation is attempting to address the issue.

The Dot Com crash case study

Next week in class we're looking at the Dot Com crash. One of the things to think about: is there any parallel between that and the sub-prime 'meltdown' that led to the "Global Financial Crisis"? While you're thinking about that, here's a video of Emeritus Professor Sidney Winter, the Michael Crouch Visiting Professor in Innovation and Entrepreneurship at the Australian School of Business, in conversation with renowned US economist Dr Alice Rivlin.



If you can't see the video, click through here.

Costco arrives in Australia

And gives us a heads up on how they intend to make money. Via The Age.

''We operate with low margins and with our membership fees, we can sustain low margins,'' Australian Managing Director Patrick Noone said in an interview. ''Lower prices are important because people shop with us to get value.''

Folks I know in the States speak highly of Costco. Let's see how they go about it here.

Photo credit: Flickr user brewbooks. Used under Creative Commons licence

Credit ratings agencies (finally) facing the music?

Adele Ferguson in the Australian highlights some of the upcoming legal proceedings involving the credit ratings agencies, particularly with respect to the 'sub-prime' mortgage backed securities. Not too soon, either.

Here's the start:

THE spotlight is about to return to the culpability of credit ratings agencies in the global financial crisis following a decision by the biggest pension fund in the US to sue over "wildly inaccurate" ratings on the $US600 billion ($750bn) of synthetic derivatives sold to investors.

This, coupled with a court case to be heard in NSW Federal Court this week, could open the floodgates for third-party litigation against the credit rating agencies. It should also corral the regulators into finally doing something about the so-called independence and enormous power of agencies such as Moody's Investors Service and Standard & Poor's.

From the comments below - a link to a guest lecture by Brad Walters, General Manager, Financial Analytics, Corporate Scorecard held at the Australian School of Business, UNSW:

QAN financial and non-financial news

Another article showing the importance of knowing what you need to look for. Qantas' recent earnings announcement - Michael Pascoe goes behind the Income Statement.

Here's the start:

The passenger figures Qantas released to the stock exchange yesterday weren't flash - but the unannounced financial reality was much, much worse.
While Qantas told the ASX its May Qantas International and Jetstar International revenue seat factors were up 4 and 4.8 percentage points respectively, it didn't say that its yield on the combined international business had collapsed by 25 per cent.

Understanding how QAN makes its money is the starting point.

CEO compensation - here come the $$s

Looks like the GFC isn't hurting the bankers too hard, over in the U.S at least. The Wall Street Journal has the details. Well sort of, you only get the highlights of the article unless you are a subscriber.

Meanwhile, back in Australia, investors are told to keep an eye on executive pay. Quite rightly, too! Mirriam Steffens in the SMH with the details.

Dividend yields

High dividend yields - can they be sustained? Here's Tim Boreham in the Australian having a look.

Let's all raise capital

Australian companies are leading the world in capital raisings it seems, and part of the reason is the Australian regulations that make capital raisings easier to undertake.

Super funds seem to be looking for investments, and rights issues at below market seem to be attractive.

Analyst coverage and small cap firms - Australian evidence

Yep, happening here as well. The Australian reports.

It all suggests that the firms themselves see analyst coverage as important, notwithstanding the recent (& ongoing) criticism that securities analysts have come under. Assuming that research on small caps is informative, or that the visibility from coverage is beneficial, there's some scope for the market to fill the demand for small cap research.

Analyst coverage matters?

Seems to, according to this Wall Street Journal article (subscription required to view full article). Here's how it starts:

A year ago, investment analysts from seven brokerage firms shadowed the financial progress of Intevac Inc., a small, Santa Clara, Calif., technology firm. Today, a lone analyst is all that remains.

"That coverage was pretty important to us," says Jeff Andreson, Intevac's chief financial officer. Among other woes, losing coverage "hurts liquidity, making it harder for our institutional investors to build or sell positions," Mr. Andreson says.

Intevac isn't unique. Whether due to layoffs, attrition, retirement or brokerage firms moving analysts around, Wall Street's map of corporate coverage is shrinking these days.

Westpac cuts dividend

Westpac joins the ranks of the dividend cutters this week. Some accounting analysis helps explain why.

More bad debts for the banks

Some of the banks are set to report this week, and more doom and gloom is expected, particularly with respect to bad debts. Bad debt provisioning is always one area where managers have some discretion. In the current climate, asset writedowns are also going to be of interest, and have been the focus of discussion of Macquarie's recent results announcement.

Banks and mark to market

Here we (finally) have a defense of mark-to-market accounting - in The Economist.

Key graphs:

Standard-setters should defuse the argument by making clear that their job is not to regulate banks but to force them to reveal information. The banks, their capital-adequacy regulators and politicians seem to dream of a single, grown-up version of the truth, which enhances financial stability. Investors and accountants, however, think all valuations are subjective, doubt managers’ motives and judge that market prices are the least-bad option. They are right. A bank’s solvency is a matter of judgment for its regulators and for investors, not whatever a piece of paper signed by its auditors says it is. Accounts can inform that decision, but not make it.

What they used to teach you at Stanford

Seven lessons learned by someone who received an MBA back in 1972.

Value investing - still appropriate?

Ben Steverman in Businessweek asks whether value investing is still the way to go.

Disciples of the value strategy, like Berkshire Hathaway's (BRKA) Warren Buffett, focus on the long-term intrinsic value of a company, hoping to buy shares in good companies at reasonable prices. By focusing on value, they avoid fast-growing firms with expensive stocks, and, by thinking long term, they try not to worry about the fickle gyrations of the market from month to month or day to day.

But amid a severe recession and financial crisis, true value has proven to be a slippery concept. "It's only a value if you can accurately assess today what the future profits will be," says Richard Sparks of Schaeffer's Investment Research. Particularly for financial stocks—some of which haven't or won't survive the crisis—it's nearly impossible to identify the long-term value, whether through profits, cash flow, or other measures.

Buffet on mark to market accounting

Warren Buffet offers his thoughts on accounting and the GFC. WSJ link here

Now comes Warren Buffett, a big investor in Wells Fargo, M&T Bank and several other banks, who, during his marathon appearance on CNBC Monday, clearly called for suspension of mark-to-market accounting for regulatory capital purposes.

We add the italics for the benefit of a House hearing tomorrow on this very issue. Mark-to-market accounting is fine for disclosure purposes, because investors are not required to take actions based on it. It's not so fine for regulatory purposes. It doesn't just inform but can dictate actions that make no sense in the circumstances. Banks can be forced to raise capital when capital is unavailable or unduly expensive; regulators can be forced to treat banks as insolvent though their assets continue to perform.

Mums and dads and super

Mums and dads don't understand super, apparently.

More reform pushes for credit rating agencies

And they need it, too. Though to say that they 'caused' the GFC is attributing a bit too much blame, I think.

Richard Glayas in the Oz.

Private equity and Pacific Brands

Looks like the PE guys did OK out of Pacific Brands.
Michael West in the Herald has the story.

Invest in index funds?

More evidence (reported in the New York Times) that it's hard to systematically beat the market.

Similar stuff from Australia - this time the Sydney Morning Herald.

Dividend imputation

Ken Henry, the head of Treasury, flags a possible change in the taxation treatment of dividend income. Hmmm; as long as they don't ONLY remove imputation, then it could work. Recall that the arguement for imputation is that it removes the double taxation on dividends; first in the hands of the company as it pays tax on its taxable income, and then in the hands of the investor when it receives that income in the form of a dividend.

Naughty baords

Terry McRann reports

And more from Andrew Main about disclosure (particularly of bad news).

CEO pay and its disclosure

Lots of media coverage of CEO pay, especially in light of the Pacific Brands decision to move some operations to China. Here's an example.

Michael West in the Herald also chimes in.

Two quick thoughts:
1. Why should government-imposed 'caps' on pay be limited to the business sector (or more particularly, to firms that receive some sort of government assistance)? Why not entertainers, or sportsmen who receive say Australian Institute of Sport assistance. Let's at least be consistent.

2. In the case of Pacific Brands, the bonuses in question appear to have been earned in 2007-08, which happened to be a record year for the company.