Posted by: sanjayshetty | October 30, 2007

Question the source, understand the true nature of the numbers

If you’re analyzing a company and the initial numbers seem to jump out at you, the next obvious thing to do, would be, to question the source. I read an interesting interview of Buffet, where one of the questions he was asked, was about CEO Compensation.(http://bankstocks.com/print.asp?id=9881373)

compensation is not rocket science. It’s very simple to determine what someone should be paid. We pay people based on what’s under their control that we care about, not on what they can’t control. If the price of oil rises to $60 from $30, oil company executives shouldn’t get paid more even though the companies’ earnings rise. If the executive can lower his company’s finding costs, that I’ll pay for. The guy is worth a lot. But the price of oil has nothing to do with it. If oil prices fall, but the company has the lowest finding costs, pay him like crazy.”

Buffet talks about CEO compensation, however, think about it… the same applies to when you’re analyzing a company’s financial data. If the company is making more money, question the source, is it because they have new orders for their products/services? Is it due to booking incorrectly, early on, monies which have yet to accrue or will not accrue in the current year (e.g. infamous case of Nortel Networks’ year 2000 fraud“), or is it cause they are not expensing an expense correctly in the current year and are spreading it over a ridiculous number of years? E.g. if a company incurs a huge IT expense and depreciates it over a period of say 15 years, one would question the decision, considering the rate at which IT solutions get extinct. (Doing this, might make it appear that earnings are quite ok.). Other examples are one time large increases in profit due to sale of an asset such as real estate, these things would need to be discounted to understand the true potential of the company.

Basically one needs to understand why numbers are, the way they are, for a company. That exploration often leads to reading the footnotes of the financial statement, or listening in on their conference calls etc. Which ever path, one follows it’s essential to understand the true cause. Question the source, always.

Investopedia has quite a number of interesting articles on these topics:

Free Cash Flow: Free, But Not Always Easy:
http://www.investopedia.com/articles/fundamental/03/091703.asp

How Some Companies Abuse Cash Flow:
http://www.investopedia.com/articles/basics/05/062405.asp

Cooking The Books 101
http://www.investopedia.com/articles/analyst/071502.asp

Common Clues Of Financial Statement Manipulation
http://www.investopedia.com/articles/07/statementmanipulation.asp

Footnotes: Start Reading The Fine Print
http://www.investopedia.com/articles/02/050102.asp

Added the following on 1st November 2007

Warning signs in earnings reports
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/articles/warnsign.htm

Off Balance Sheet Items?
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/articles/offbalancesheet.htm

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Responses

  1. I am very interessed in the Indian stockmarket
    Thank you for your articles
    Do you know a site where i can download
    historical stockquotes ??

    Thank you for your time
    Piet
    The Netherlands

  2. Hi Piet,

    As far as I’m aware, the best formatted information is available on yahoo http://in.finance.yahoo.com
    it makes data available as as Excel spreadsheet as well. It provides daily/weekly/monthly etc. Open High Low Close Volume data for a company of your choice and it covers the Indian market.

    Regards,

    Sanjay Shetty


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