Sunday, July 26, 2009

Wise Investment

The book "How To Figure Out Company Accounts" by Michael Brett has some good advice for anyone who is considering direct investment in a corporation. On page 133, he recommends that:

If you really want to get to grips with a company's report and accounts, here's a bit of advice. Start with the figures themselves: the profit and loss account, cash flow statement and consolidated balance sheet. The real purist would go even further: read the notes to the accounts before you even read the accounts, as that's where any 'nasties' are going to be tucked away, well out of the spotlight. Remember that there are certain things a company must, by law, disclose. But there's no law against companies making generous use of the public relations industry in the way they choose to present material, and most of the bigger ones do. At the same time, check on the auditor's report to make sure there are no unpleasant surprises there and have a glance at the note on accounting policies. If there have been changes in policies over the year this always deserves a second look.
There's no point in trying to learn accounts interpretation in the abstract. Have a set of accounts in front of you. See first of all what impression you get of the company and its current state of health from the bare figures. It's not easy at first but you develop an instinct for homing in on the important areas once you've looked at a number of different sets of accounts. There will, at the very least, be some points of detail you cannot fully comprehend from the bare figures; but form your own broad impression. Only after that should you begin looking at the chairman's statement, chief executive's review and finance director's report to see if what you find there confirms and amplifies what the figures have told you. They should at least help to explain some of the points of detail that confused you. And, as we've said elsewhere, a really good finance director's report, read in conjunction with the figures, can provide an excellent grounding in the principles of corporate finance in general.

Brett goes on to offer more advice about more specific and detailed financial indicators. Towards the end of the book, he share his translations of the kind of 'weasel words' to watch out for. Here are a few:

'Unfortunately, our widget division suffered very difficult trading conditions in the second half...' Thanks to our failure to invest in new production plant, our competitors knocked the stuffing out of us in the widget market.

'The company's remuneration policy is to provide competitive remuneration packages which enable the company to attract, motivate and retain executives of high calibre.' And since every other company's bumping up its pay and perks packages to do exactly the same, boardroom pay continues to rise at about five times the rate of general wage inflation. But we're not complaining.

'The operating culture of the group now embraces internal control and continuing assessment of risk...' Previously, we crossed our fingers and hoped.

Of course, this kind of analysis is designed for one corporation. Analysis of the potential for return on investment in a fund (such as those offered in deferred compensation plans) should be based on the funds' analyses of the corporations whose stocks, bonds, and securities they are considering.
Now many of us will never practice this kind of scrutiny ourselves. But in the free market, it's 'buyer beware,' and we can question the advertising and competence of multinational corporations before investing in their products. And as CalPERS members, the more we understand about financial affairs, the better we can comment about CalPERS direction.
But I don't think we can limit ourselves to traditional financial analysis of this or that company; we must keep the overall economic picture in mind. For example, despite recent stock market trends, the long-term outlook is clouded. Any improvements in transparency and fairness would be helpful.

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