Funky Accounting and the Moola!

(Continuation of the wonderful compilation of Warren Buffett's sayings done by Bud Labitan called "The Warren Buffett Business Factors" but unfortunately the link I had recorded is broken.)

Accounting

Funny business in accounting is not new. I have a previously unpublished satire on accounting practices written by Ben Graham in 1936. Excesses similar to those he then lampooned have many times since found their way into the financial statements of major American corporations and been duly certified by big-name auditors. Clearly, investors must always keep their guard up and use accounting numbers as a beginning, not an end, in their attempts to calculate true "economic earnings" accruing to them.

Berkshire's own reported earnings are misleading in a different and important, way: We have huge investments in companies ("investees") whose earnings far exceed their dividends and in which we record our share of earnings only to the extent of the dividends we receive. The extreme case is Capital Cities/ABC, Inc. Our 17% share of the company's earnings amounted to more than $83 million.

Yet only about $530,000 ($600,000 of dividends it paid us less some $70,000 of tax) is counted in Berkshire's GAAP earnings. The residual $82 million-plus stayed with Cap Cities as retained earnings, which work for our benefit but go unrecorded on our books.

Our perspective on such "forgotten-but-not-gone" earnings is simple: The way they are accounted for is of no importance, but their ownership and subsequent utilization is all-important.

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Funny business (or should I call it as Funky Business?) in accounting is not new!

Now I believe Warren has given a really solid investing advice here by saying that investors must always keep their guard up and use accounting numbers as a beginning, not an end, in their attempts to calculate true "economic earnings" accruing to them.

What Warren means by using accounting numbers as a begining, not an end is that an investor should not base their final investing decision solely on what they see in the accounting numbers.

Take for example.. err... Megan: Part IV

Now say in end June 2005. See the following.

Quarterly rpt on consolidated results for the financial period ended 30/4/2005
1. Sales 267.602 million.
2. Net profit 21.107 million.

Now if an so-called investor based their investment decisions soley on the so-called accounting profits, they were looking at a company which had seen its net profits increse by 5.47 million a quarter ago or a whopping 35% on a quarterly basis. On a year-to-year basis, this represented a 30% net profit growth. (ah.. see how deadly it is to be seduced by such so-called growth?)

Impressive? Now if the investor had based their investment decision on these facts alone, then the investor would have faced disastrous valve destruction in their investment. Back then in June 2005, Megan was trading in the 1.20 region. Now? It last ended the day trading less than 0.70.

What went wrong?

Two clear cut issues that indicated that this stock was simply a death trap for investors investing based on the accounting profits is (1) the ballooning debt and (2) the lack of wealth being created in the company.

So what is this lack of wealth being generated despite the fact that this company announcing an accounting profit of over 66 million?

Take the piggy bank as the simpliest of wealth indicator. On that earnings report, Megan's piggy bank cash equivalent totalled some 35.467 million. A year ago the piggy bank cash was at 37.218 million. Which means for that fiscal year, Megan's piggy bank cash depleted. And what as the total accounting net profit announced by Megan? Some 66.167 million! How? Company announced it made 66.167 million. But the company's piggy bank does not seem the issue that greath weath had been created! (ps... in me terrible Chinese-English again, Aiseh! if I tell me Ah Poh-Poh I every month earn some 50k but yet everytime, night-night I always chee-chan and no come out money or my ho-pow always empty and worse still, if hit mahjong, lose money I day-day to be on tok-soh, then surely my Ah Poh-Poh knows that I am simply a big bruffer!)

Commonsense question: Where Is Ze Moola? Where?

And the most damaging answer came in the issue of trade receivables! Total trade receivables was some rm252.957 million. (increased by rm54.519 mil a quarter ago!) A year ago, the trade receivables was some 190 million. Two truly incredible issues. (1) On a quarterly basis, trade receivables increased by 54.519 million. This increase in the amount of trade debtors is even more than Megan's quarterly profits. (2) On a yearly basis this trade receivables increased by some 62 million, which is just slightly less than Megan's accounting net profit of 66.167 million. Incredible funky business! And shouldn't have the prospective intelligent investor question this trade receivables issue way back in June 2005?

Anyway, isn't this what Warren is saying that one should not use accounting numbers as an end for their investment decisions? See the end-results?

Subsequent utilization (of the cash) is all-important.

How very true!

What is the company doing with the cash?

Is the company hoarding the cash?

Is the company distributing the money back to shareholders in a prudent manner?

Or is the company simply finding way(s) to abuse the money for they, themselves?

For me, I believe it is very important for us, the minority shareholders, to address such issue before we invest in a company. Self-protection by avoiding questionable investment(s) is always better than crying out loud for injustice done to us by unscrouplous corporations who treats minority shareholders as nothing more as other people's money (OPM). And since we represents OPM, these unscrouplous companies thinks that we are simply there waiting to be suckered!

Do we really want to be such a minority shareholder?

Oh.. I have heard some ludicrous comments before that sometimes certain listed companies do not want to share their weath, so they 'hide' their profits. Ah, yes this is very much possible. In a crooked world, who are we not to say it is not possible?

And the commonsense thingy... since they are hiding their profits, aren't these companies being less than honest?

And if they are not honest, why on earth do you want to trust your hard-earned money by investing in such a company?

And since they were willing to hide their profits, do you think they are willing to share their profits?

Makes no sense to me... none at all!

It's simply ludicrous to have such a reasoning to 'invest' in a company!