Ten Questions Every Investor Should Ask

Janice Revell in Fortune produced a really good summary for equity analysis. Read it here.

Again, what's the number one rule?

1 HOW DOES THE COMPANY MAKE MONEY?

If you don't know what you're buying, you're hardly in a position to know what you should be paying for it. So before you buy a stock, you need to get a handle on how the company earns its dough.

How did they value stocks?

A good old article (from 2001, yep, 2001!!!) from Gretchen Morgenson in the New York Times discussing the ways that analysts and salesmen were trying to value stocks back in the internet bubble days. In short, because these companies weren't reporting positive earnings, folks were looking for something else to use as a valuation metric (like number of viewers, or internet clicks, or marketing expenditure). Turns out that turning a profit is still a good way to stay in business, and continuing to make losses is a good way to go out of business.

The article (page 3) also discusses the extensive use of 'pro-forma' earnings numbers being peddled by companies at the time (and it still continues).
Last para in the article reads:

Byron Wien, chief United States investment strategist at Morgan Stanley, is fearful that companies that spin their results using pro forma figures could do serious damage to investor confidence in the financial markets. "Corporations have a lot of flexibility in how they report results," he said. "Nobody knows more about the truth than the corporate executives themselves. Taking a short-term view of truth may make things look good in a quarterly report. But it will ultimately catch up with them."

That is a good description of what seems to be happening today.

And continuous today.

Warren Buffett

Here's the latest Chairman's Letter from Berkshire Hathaway: pdf link. Have a read.

And a key section (from page 6):

Businesses – The Great, the Good and the Gruesome
Let’s take a look at what kind of businesses turn us on. And while we’re at it, let’s also discuss what we wish to avoid.

Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag. We like to buy the whole business or, if management is our partner, at least 80%. When control-type purchases of quality aren’t available, though, we are also happy to simply buy small portions of great businesses by way of stockmarket purchases. It’s better to have a part interest in the Hope Diamond than to own all of a rhinestone.

A truly great business must have an enduring “moat” that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business
“castle” that is earning high returns. Therefore a formidable barrier such as a company’s being the lowcost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success. Business history is filled with “Roman Candles,” companies
whose moats proved illusory and were soon crossed.

* Photo taken from JasonSmith's public flickr stream. Original photo found here.

When in doubt, blame the accounting rules

That's what's happening in the U.S., with respect to losses being recorded by some of the financial services firms. The requirement that financial instruments be 'marked to market' means that when the value of the loans (i.e. the investment in the loans made by the financials) falls, this needs to be reflected in the balance sheet.

Wall Street Journal article. Key grafs:

But these market seizures are what have made market values so contentious. Robert Herz, chairman of the body that sets the accounting rules governing the use of market values, the Financial Accounting Standards Board, acknowledged the difficulty investors and companies are facing.

"But you tell me what a better answer is," he said. "Is just pretending that things aren't decreasing in value a better answer? Should you just let everybody say they think it's going to recover?"

Others who favor the use of market values say that for all its imperfections, it also imposes discipline on companies. "It forces you to realistically confront what's happening to you much quicker, so it plays a useful purpose," said Sen. Jack Reed (D., R.I.), a member of the Senate banking committee.

Got margin loans?

If you're a director, and you do have margin loans, get ready for some disclosure. The Australian reports that The Australian Securities Exchange and ASIC were going to require directors to disclose their margin loans. Red flag to a bear, anyone?

ABC Learning: debt issues

Some financial policy analysis; particularly leverage (debt).

The unfortunate ABC Learning again. The amount of debt, the conditions relating to the debt, and the quality of assets supporting the debt are all referred to here.

How to short sells and win!

Andrew Main in The Australian.

Current or non-current liabilties?

Turns out, the difference is important. Allco Finance Group, who've been in the news of late, issued financial statements with just under $2billion of liabilities classified as non-current, when they should have been current. Elizabeth Knight argues that they company and it's auditor (KPMG) should have been slightly more forthcoming about 'correcting the record'. She refers to both audit and non-audit fees paid to KPMG; two things often said to be associated with auditor independence.

Who's to blame?

Michael West summarises the gnashing of teeth about the current 'meltdown'.

Key paragraph:

There is a pattern to these implosions. Every company - Centro, Allco, MFS and now ABC Learning - have five things in common: greed, leverage, risk, suspect corporate governance and complex corporate structures.

and also:

Moreover, on transparency, we won't hear too much from the ASX as it has made a mockery of transparency by kowtowing to the big investment bank clients and making the broker identities on its own trading system anonymous. Its own disclosure is not good enough.

To ASIC, the corporate watchdog; both its bite and bark are small.

There's a book in the reasons why but one is cultural. The SEC in the US is a far more rigorous sheriff.

Let's see how much changes.

Meeting analyst forecasts

Is still considered important. Here's a report about QBE who missed analyst forecast in their recent half yearly profit announcements. Share price dropped, as is usually the case.