Investor backlash

By Goh Thean Eu

Published: 2011/05/04

Kuala Lumpur: Companies that were red-flagged by auditors and those that reported stark difference in their audited net earnings, saw their stocks punished by investors yesterday.

The selldown in some of the companies was systematic, as inves-tors were wary of their long-term prospects.

Since Friday, some 16 companies either had their books qualified by external auditors, or had revealed significant variance in their audited net earnings.

From the 16, eight companies saw their share prices fall, while two closed unchanged. Shares in the other six companies were untraded yesterday.

Sumatec Resources Bhd saw its share price fall by as much as 48 per cent to close the trading day 13 sen a share.
The Sumatec warrant, which also one of the top 10 actively traded securities fell by more than 50 per cent to 7 sen.

Sumatec's auditors SJ Grant Thornton was not convinced of the company's ability to secure new contracts.

The auditor highlighted that Sumatec did not impair goodwill on its subsidiary's consolidation and deferred tax assets of RM33.48 million and RM13.15 million respec-tively.

It also added that the company's trade receivables of RM5.91 million have been long outstanding and not impaired.

"I think, in most cases, the auditors are just making sure that provisions are being made on uncollectable debts. The rule of thumb today is to make provision for debts that can't be collected in six months," said Jupiter Securities head of research Pong Teng Siew.

Other notable stocks that fell include DBE Gurney Resources Bhd and Alam Maritim Resources Bhd.

DBE's shares fell by more than 5 per cent after it reported an audited net loss of RM3.71 million, more than 17 times of its unaudited net loss of RM202,000.

Meanwhile, Alam Maritim's shares fell by 4 per cent after it announced an audited net loss of RM12.9 million for the financial year ended December 2010, as compared to its unaudited net profit of RM2.2 million.

According to analysts, these variance between unaudited and audited numbers will, to a certain extent, change investors' long-term view of the companies.

"As you can see in today's selldown in some of the stocks, investors do take into account all these. Variations like these will make investors cautious of a company's sustainability and the credibility of its unaudited accounts," OSK Research head of research Chris Eng added.

While most analysts feel that most of these "incidents" are mainly driven by companies' misinterpretation of the new accounting standards, some feel that it could be a sign of more bad news to come.

"I think we can't discount the fact that it may be a prelude to bigger adjustments later," said Pong.

Read more: Investor backlash http://www.btimes.com.my/Current_News/BTIMES/articles/redred/Article/index_html#ixzz1LKi3cT2u

Buffett (2002): Three suggestions to help an investor avoid firms with management of dubious intentions.

After enthralling readers with a wonderful treatise on how good corporate governance need to be practiced at firms in his 2002 letter to shareholders, Warren Buffett rounded off the discussion with three suggestions that could go a long way in helping an investor avoid firms with management of dubious intentions. What are these suggestions and what do they imply? Let us find out.

The 3 that count

The master says,  "First, beware of companies displaying weak accounting.There is seldom just one cockroach in the kitchen." If a company still does not expense options, or if its pension assumptions are fanciful, watch out. When managements take the low road in aspects that are visible, it is likely they are following a similar path behind the scenes.

On the second suggestion he says, "Unintelligible footnotes usually indicate untrustworthy management. If you can't understand a footnote or other managerial explanation, its usually because the CEO doesn't want you to."

And so far the final suggestion is concerned, he concludes, "Be suspicious of companies that trumpet earnings projections and growth expectations. Businesses seldom operate in a tranquil, no-surprise environment, and earnings simply don't advance smoothly (except, of course, in the offering books of investment bankers)."

Attention to detail

From the above suggestions, it is clear that the master is taking the age-old adage,  'Action speak louder than words', rather seriously. And why not! Since it is virtually impossible for a small investor to get access to top management on a regular basis, it becomes important that in order to unravel the latter's conduct of business; its actions need to be scrutinized closely. And what better way to do that than to go through the various filings of the company (annual reports and quarterly results) and get a first hand feel of what the management is saying and what it is doing with the company's accounts. Honest management usually does not play around with words and tries to present a realistic picture of the company. It is the one with dubious intentions that would try to insert complex footnotes and make fanciful assumptions about the company's future.

We would like to draw curtains on the master's 2002 letter to shareholders by putting up the following quote that dispels the myth that manager ought to know the future and hence predict it with great accuracy. Nothing could be further from the truth.

CEOs don't have a crystal ball

The master has said, "Charlie and I not only don't know today what our businesses will earn next year; we don't even know what they will earn next quarter. We are suspicious of those CEOs who regularly claim they do know the future and we become downright incredulous if they consistently reach their declared targets. Managers that always promise to 'make the numbers' will at some point be tempted to make up the numbers."

Hence, next time you come across a management that continues to give profit guidance year after year and even meets them, it is time for some alarm bells.

http://www.equitymaster.com/p-detail.asp?date=8/20/2008&story=2

Investors and Accounting

Buffett encourages investors to develop a good knowledge of accounting.

In a Berkshire shareholders' annual meeting, a New York University MBA student asked Buffett for his advice on how to develop Buffett-like skills.  In his response, Buffett mentioned that the student should take as many accounting course as possible.  

Remember that you are a consumer and not a prepare of financial information.  Act like a detective trying to understand the company's business from reading financial statements.

Buffett reads a lot of financial reports; and for him, perhaps, that is like reading detective novels.  As a reader of financial statements, you could have fun discovering behind-the-curtain stories.

Accounting numbers are based on a large number of estimates, and hence, they are not really hard numbers.  Yet, academic  research shows that long-short investing strategies can often be developed by using accounting knowledge.  

When you study financial statements, be a skeptic.  Most accounting numbers are reliable, but you must remain vigilant.  


Related readings:

Videos-Financial Accounting by Susan Crosson

Where is Ze Moola

Visit this site to see how this blogger dissect the companies through using his accounting and other knowledge. 

Do Sophisticated Investors Understand Accounting Quality?

Do Sophisticated Investors Understand Accounting Quality?

Evidence from Bank Loans

Since banks significantly rely upon financial statements to assess and monitor borrowers’ accounting quality, we measure accounting quality as the magnitude of abnormal operating accruals, after controlling for industry and the firm’s normal level of activity. Operating accruals represent the difference between the reported earnings and the operating cash flows of a firm. Large deviations between earnings and operating cash flows make it harder for the bank to assess the ability of borrowers to generate cash flows in the future. Differentiating between earnings and cash flows is crucial for the bank because the payments by borrowers in the form of interest or principal will be serviced out of cash flows.


IV. Conclusion

We examine if banks have the ability to understand the relationship between operating accruals, future earnings and cash flows. Differentiating between earnings and cash flows is crucial for the bank because, the payments to the loan contracts in the form of interest or principal will be serviced out of cash flows and not earnings of the borrower.

This issue is important since various papers have documented that stock market investors (Sloan (1996); Xie (2001)) as well as sophisticated bond market investors (Bhojraj and Swaminathan (2004)) do not seem to price poor accounting quality as reflected in accruals.

In sharp contrast to these studies we find evidence in support of (Working Capital/ Total Assets) + 0.076 (Current Liabilities/ Current Assets) – 1.72 (1 if Total Liabilities >Total Assets, 0 otherwise) – 0.521 ((Net Incomet - Net Incomet-1)/( Net Incomet + Net Incomet-1)) the banks being able to discern the true accounting quality of borrowers and incorporate loan terms, price and non-price terms, appropriately.

Our paper makes four contributions to the literature.

• First, by showing that banks consider the deviations between cash flows and earnings in pricing and structuring their contracts, we provide direct evidence supporting the specialness of financial intermediation. The financial intermediation literature has hitherto relied on indirect evidence supporting the specialness of banks.
• Second, we add to the growing body of evidence that investors misprice information in financial statements, by showing that some sophisticated investors (banks, in our case) properly use this information while structuring financial contracts.
• Third, we advance the explanation that our results support, and are consistent with, the notion of limited information as a source of risk – a view increasingly gaining currency in the asset pricing literature.
• Finally, we show how accounting quality has a direct and measurable impact on a firm’s cost of capital.

http://www.bis.org/bcbs/events/rtf04sunder.pdf