Was just reading the following posting on NationalPost, Can you trust your financial advisor?
In that post, it highlights a video clip on CBC: here. Do give it a view. :D
This reminded me of an article I read last year also. Ripped Off: Can You Trust Your Financial Adviser?
And on a much broader sense, this old article deserves to be highlighted again.
Anthony Deden wrote In Whom Do You Trust? Semper (In)Fideles
- We can never make any investment without running these sorts of risks – indeed, the returns to our investment arise directly as the reward we earn because we are running them.
On the other hand, if the accountant is fudging the books, or if the company declares assets which don’t exist, or if the CEO is otherwise deceiving his shareholders and creditors – clearly, this is a very different sort of hazard. This is what we mean by "unsystematic" risk.
A moment’s thought will show that it is highly problematical – to the point of impossibility – to uncover the existence of such risks until it is too late. Fraud is generally undetectable unless one has complete access to all the books and complete freedom to question their entries. Even then, one must know what questions to ask – a difficult task in itself in today’s world, where there is no shortage of executive brainpower devoted to ensuring that even the questions are well obscured.
Mr. Deden then gave some excellent investing advice.
- Keep the red flag flying
We have laid out all the above in the hope it might prove useful in clarifying and identifying some of the little-regarded sources of risk. We will skip past the densely packed minefields of accounting and auditing (q.v. Enron, WorldCom, Parmalat, et al.) for another time.
In the end, if we should not rely on the rules and accounting standards, or on mathematically tractable entities, to mark out dishonesty and incompetence, and if we cannot identify malfeasance directly from an Excel spreadsheet, what hope do we have to survive? Or, must we withdraw from the market completely, perhaps pausing only to bury a few gold coins in the soil? Perhaps not.
Far from that, we believe there are a number of readily comprehensible, qualitative and perhaps intuitive considerations to which we can turn when examining the securities of a company. Any one of these signals should give rise to serious doubts about the overall suitability of a given investment. If more than one such factor is in existence – and believe me, these bearers of bad news tend not to travel alone – a huge red flag should prompt us to utterly reject the investment altogether. It is far better to overlook a good company not fully understood than to pack a portfolio with unmarked dirty bombs; however en vogue they might be.
For every investment idea rejected out of a sensible exercise of prudence, there are a multitude out there somewhere – presently unknown or perhaps not yet even founded – that are far more worthy of interest and money.
Six (financial) flags
Not enough "stuff" – Deficiencies in net tangible assets. This is clearly a basic banking approach to lending that can also be used by equity investors. When a company’s balance sheet is stripped of intangible assets, ‘other assets’ and any other items which are only financial in nature, what is left is the tangible asset base – the "stuff" the company really uses to pay its suppliers, hire its workforce, repair and upgrade its equipment and to generate wealth for its owners. If there do not seem to be enough of these in comparison to the rest of the entries in the accounts one should start to wonder whether stocks and machinery have been replaced by smoke and mirrors. The wellspring of "write downs" starts with a hollow balance sheet.
Mergermania – Excessive acquisition activity is also a sign of ill health. Nothing truly great was ever built via a process of fevered acquisitions. This is not to dismiss all takeovers, regardless of circumstance, but to point out that they are usually far more lucrative for the corporate financiers and insiders than for the company stockholders. Frequent acquisitions are a sign of weakness, of misplaced priorities and of the inability to enhance worth from within.
More growth – and at any price. In practice, this usually means growth at too high a price. Market share is not what matters but return on capital. Profitability is what counts, not mere turnover, much less "eyeballs" or any of the other New Era nonsense metrics. No honest business ever grew in an uninterrupted geometric progression – especially not one in double digits. Life just doesn’t come in such neat packets, no matter what Jack Welch might say in his latest airport executive pep-talk.
Too many trips to the well. Frequent recourse to the financial markets for funding is another danger sign. A good business makes money by reinvesting its profits, not by slowly mortgaging itself to its bankers or by continually diluting its owners.
Too much fine print. If the annual report has more fine print than a budget edition of "Gone with the Wind," the firm’s shareholders will only get to dream of Tara; they will never know her. Well-run companies have simple and straightforward accounts. Lots of fine print can either imply the company doesn’t know what it’s doing – or that it doesn’t want you to. In the end, more often than not, fine print raises more questions than it answers.
Lack of substantive ownership by those at the top – and presumably by those in the know – is hardly a ringing endorsement of a business. If the CEO and his buddies only hold stock through option grants and never actually pay for their holdings, and if the members of the board have better things to do with their pensions than to waste them on the company they supervise – who are we to argue?
Five (Behavioral) flags
Managing the stock, not the company. We believe that in an entrepreneurial setting, the price of common stock is merely the reflection of wealth rather than wealth itself. To the extent that the Street and the stock ticker become the focus of a company’s management, we would swiftly avert our own gaze. Wise, long-term decisions cannot be made when most strategies adopted are aimed at flattering the next quarter’s numbers. In recent years, in fact, CEOs will even give "guidance" to analysts as to future sales and profits – a practice which, at heart, is designed merely to support and cater to share price management.
Tell me something I don’t already know. More often than not, a firm which insists on calling in consultants at every turn becomes hooked on the avoidance of full managerial responsibility, no matter how it may justify it. Consultants often know little more (and sometimes quite a lot less) about a business than the people working there. Typically, they are an expensive way to confirm the Boss in something he lacks the resolve to implement himself. Quite often, consultants are also a sure sign of a firm in which ideas have dried up because of poor internal communication, strained employee relations, or limited understanding of the customer.
Who are those people cluttering up the shop? In the free market, the consumer is king and anyone who loses sight of this simple truth is likely to be thrown out of the kingdom. By succumbing to the lure of Wall Street – induced empire building, many companies have lost sight of whom they serve. The same condition often causes them to neglect their employees also – meaning they end up with unhappy people on both sides of the counter.
Packing the Court. If you think that the board of directors has been picked in order to curry political favor, or to provide a chorus to sing "Yes!" in harmony to the CEO, beware! Does the company routinely offer sinecures to petty aristocrats, or does it participate in the revolving door back-scratching of those on the government-boardroom-bureaucracy carousel? Does the board consist of a fashionably correct ethnic or gender-based mix – where the persons concerned seem to have been chosen for PR reasons, not on personal merit? Are there figureheads around the table, rather than independent and respected voices who can defend the shareholders from the worst impulses of a dictatorial CEO?
Rock’n’Roll Cowboys. The CEO is the person employed by the owners to put their capital to work in running a business. Let us not forget, he is (admittedly very expensive) hired help. His role is to serve the owners to the best of his ability. An inveterate show-off, less well known for his business acumen than for his yachting exploits, his mistresses, his sports sponsorship, his politics, or any of a number of other extra curricular pursuits, would not make it past the selection panel if you and I had been asked to sit on it. If the guy wants to be an Emperor, let him emigrate to Ruritania. If he wants to be a rock star, let him go take a few guitar lessons. Meanwhile, I want to invest in an entrepreneur who is too busy running the company for such distractions and is humble enough to know that there is always more he does not know than there is that he does. The first guy will doubtless make himself rich: the second might make his owners rich instead.
We earnestly hope the foregoing has given the reader a few pointers as to where he should start exercising "street smarts" in the selection of investments. Once honed and directed, these intuitive skills – when wedded to the analytical capabilities which anyone can acquire with a little study – should act as a defense mechanism against the many elusive unsystematic risks that plague our financial world.
In the end, one can only trust his own judgment, intuition and skepticism, not only in investment selection but also in the selection of those to whom he conveys fiduciary duty.
If one can manage to spot the red flags, warning signs and maintain discipline in the face of great challenges – resist the tug of the ticker tape and the smooth talk of the stock salesmen and uppity bankers – then that person might just stand a chance against great odds.
We reckon that’s a lesson which is worth at least half of a hundred and fifty million francs
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