In January 2000, Jeffrey McMahon—then Enron’s treasurer—made a pres- entation to the rating agencies. His goal was to communicate the message that Enron’s stock was underrated. The problem he faced was that there were a number of “misperceptions” about Enron floating around out there. He called them “myths,” which he then tried to dispel:
MYTH:There are massive amounts of debt that is not included in Enron’s credit profile.
FACT:The inclusion of all obligations (without adjustment for non-recourse) does not materially change the financial profile of Enron.
MYTH:Management does not communicate its true financial position to the investor community or the rating agencies.
FACT:Management is extremely accessible to anyone willing to take the time to understand its credit—banks, institutional investors, rating agencies.
MYTH:Enron dealmakers worldwide aggressively pursuing new business lines bind the company without centralized approval and control.
FACT:Risk and assessment controls policy requires the approval of Enron Corp. senior management and the board of directors to bind the company.17
Orwellian, isn’t it? I personally find it hard to imagine talking to a fairly hard-nosed bunch of analysts and telling them the exact opposite of the truth. As we have all learned, however, many of us to our sorrow, McMa- hon’s “myths” were facts, and his “facts” were myths.
This again raises the issue of corporate culture, cited in previous chap- ters. Enron was known for the “smart” tone of its conference calls. Its man- agers were getting away with murder, they knew it, and they were proud of it. And right up until the end, the best defense is sometimes a great offense.
I noted at the outset of this chapter that two good trends are now well under- way: increased SEC scrutiny and a new wave of corporate self-policing. The New York Timesrecently reported an example of the latter, which may serve as a helpful antidote to much of what has been laid out in preceding pages:
“A success story in building confidence comes from AmeriCredit, an auto- mobile loan company in Fort Worth. Five years ago, its chief financial offi- cer, Daniel E. Berce, recognized the complexity of his business and set out to make it easier for investors to understand. AmeriCredit began broadcasting conference calls on the Internet, making extra financial data available online and building an investor relations department to explain the numbers.”18
Of course, Mr. Berce’s story can only be as good as AmeriCredit’s num- bers (which we will assume to be accurate). However, it is these kinds of confidence-building measures that are going to be needed—from corporate headquarters across the nation—before investors will be willing to return to a market that has bruised them badly.
MASSAGINGFINANCIALREPORTS 163
LESSONS FOR THE INVESTOR
In financial statements, top is better, bottom is worse.The closer the information is to the beginning of the statement, the less processed and more trustworthy the information is likely to be.
It is all about earnings.This used to be a good thing, back in the days when earnings translated into dividends. Now it tends to be a bad thing because earnings-obsessed companies are tempted to defend and manipulate their stock prices—driven by the prospect of capital gains—in all sorts of seamy ways.
When it is not all about earnings, worry about the new focus of attention.As soon as corporate executives started focusing on the once-reliable cash-flow numbers, those numbers started getting less reliable.
The quantitative is often qualitative. Do not be wowed by columns of numbers that line up and then add up. They are being used to paint a certain kind of picture. You, as the investor, have to figure out how accurate that picture really is. Is it timely? Is it comprehensive?
Watch out for corporate viruses.When a company learns a bad trick—such as Enron’s version of “earnings management”—they tend to teach it to other companies. Bad practices thereby get exported.
Keep your eye on insider trading.Especially the legal kind, which is all you are likely to find out about in time to act. What do the Form 4s and Form 5s tell you about senior management’s confi- dence in their company?
Apply the sniff test.Your gut feeling or intuition about a company is not a bad method of assessment. An overly aggressive tone in a conference call to investors, for example, can be a bad omen.
Don’t cut ’em any slack.If you find out that one of the company’s claims cannot be trusted, don’t believe any of its claims.
Reading (or Ignoring) Analysts’
Recommendations
But, as we can see from recent history, long-term earnings forecasts of brokerage-based securities analysts, on average, have been persistently overly optimistic. . . . The persistence of the bias year after year suggests that it more likely results, at least in part, from the proclivity of firms that sell securities to retain and promote analysts with an optimistic inclination. Moreover, the bias
apparently has been especially large when the brokerage firm issuing the forecast also serves as an underwriter for the company’s securities.
—ALAN GREENSPAN, Federal Reserve Board chairman1
165
12
C H A P T E R
Copyright 2003 by The McGraw-Hill Companies, Inc. Click Here for Terms of Use.
During the dot-com bubble, several research analysts—for example, Mer- rill Lynch’s Henry Blodget and Salomon Smith Barneys’s Jack B. Grubman, became the financial equivalent of pop stars. Not that their jobs at that time were particularly demanding: When they recommended a buy, the bubble meant that the stock almost always went up, and the analysts looked ever smarter. It was a virtuous circle: More “wins” meant more money coming in, which meant more wins.
Then things started to go wrong. The same star analysts told investors that a given company was a strong buy at $100 a share—even as the bub- ble was bursting, and these stocks were starting to collapse. Mysteriously, the analysts sent out the same “buy” signals again when the stock dropped to $50 and when it hit $10. In some cases, they remained just as bullish when the stock slid to under a dollar a share.
Were they simply optimists, as Greenspan’s quote implies? Or was something else at work here?