Diogenes would have a tough time finding an honest man announcing corporate earnings. In my article, Pepsi-Cola Hits The Spot?, I outlined how Pepsi trumpeted sales and profit increases, yet both actually declined.
Investors have a difficult challenge managing their life savings dealing with phony, deceptive data. Corporate America blares misleading headline numbers hoping to drive up their stock prices and bonuses. How does an average investor truly understand the real potential of investment opportunities?
Tony Daltorio has been writing about stocks for over 20 years. I’ve followed him since he started with Investor’s Alley, writing the Growth Stock Advisor. Although it’s only 3 years old, it’s returned some outstanding winners on companies most of us have never heard of like Sterling Construction (160%) and Neos Therapeutics (73%).
His recent educational email, “Tariffs, the Market and Earnings” caught my attention. He emphasized, Be Careful of Earnings “Massages”. Uncovering the truth is getting tougher and the SEC is doing nothing to help:
“…. Be very wary of executives that try to steer investors to only look at their adjusted earnings and not their earnings under GAAP (Generally Accepted Accounting Principles). …. Adjusted earnings ignore real costs of doing business such as acquisition expenses, interest payments, stock options for employees, and just about anything else that is ‘inconvenient’.
A new study…found that…more and more companies have shifted to emphasizing adjusted earnings.
…. One reason for the ‘massaging’ of numbers may be that, after a big earnings beat, stocks go up and that benefits large shareholders – such as the executives that are ‘adjusting’ their earnings.
The SEC gives its blessing to this practice as long as the company discloses how it calculated its earnings. But how many investors actually understand accounting and the intricate ‘dance’ companies now do to please Wall Street?” (Emphasis mine)
Tony makes his living recommending growth stocks. He regularly deals with earnings calls and published data as he evaluates potential investment candidates. He has to sort through the deceptive smoke and mirrors; his readers are depending on him. How does he do it?
I was pleased when Tony agreed to an interview.
DENNIS: Tony, on behalf of our readers, thank you for taking your time for our education. Let’s get right to it.
You mention the trend is for companies to “massage” their data as opposed to reporting what really happened. When I wrote my Pepsi article, I got really frustrated with the volume of mumbo-jumbo and fine print.
What do you look for, and how do you sort through the data?
TONY: Dennis, thanks for inviting me.
I try to avoid all the unnecessary stuff and just look at a few items when deciding if a company is a good investment.
First, is this company riding the wave? I’m not talking about a stock’s price momentum, but whether the company is in the sweet spot of a global macroeconomic trend that is still in the very early innings. For example, one such trend is the humanization of our pets. That makes anything connected to pet care an area I’m interested in.
Only then do I look at a company’s financial data. Are their revenues and GAAP earnings in a steady uptrend? Are they diversified globally so as not to be hurt as bad by a trade war? Does the management team have a proven track record?
DENNIS: Tony, is there data available where the company has to report the real numbers? How would our readers find that information?
TONY: I’m an avid reader. Part of my daily routine is to read through all of the financial news including the Wall Street Journal, Bloomberg, Reuters and the Financial Times.
I recommend looking at a company’s 10k for sure. I look at it not only to see the GAAP numbers but also to see what percentage of a company’s revenues come from overseas. It varies by industry. I like to see a nice percentage of revenues coming from overseas markets, which are often faster-growing than the U.S.
Second, you have to keep your fingers crossed a bit. The Financial Times did a big exposé that showed how the big 4 accounting firms (combined revenues of $34 billion) were falling down on the job. Egged on by Wall Street, they have softened the standards on things like goodwill, which makes company reports harder to decipher.
Audit used to mean to survey or check facts, but no longer. During the 2008-09 financial crisis, there was a major dispute between AIG and Goldman Sachs because misleadingly precise profits and losses on financial instruments were written, not on the basis of observation of financial market prices, but computer model calculations. Charlie Munger said, the auditors “violated the most elemental principles of common sense.”
DENNIS: I get frustrated reading analysts who tout individual stocks based on the charts touting “follow the trend”. I prefer stocks that are value priced, not overpriced.
You grabbed my attention when you recently wrote to your Growth Stock Advisor readers:
“There is a question of price and valuation. For example, I used to be positive about both Square (NYSE: SQ) and Netflix (Nasdaq: NFLX). But the valuations of both companies have gotten out of hand. I’d rather own something else.”
After you dig past the smoke and mirrors your job isn’t finished. Regardless of how well SQ and NFLX may perform, they are not the only opportunities available. What would you tell our readers about looking for values?
TONY: First of all, steer clear of the Wall Street hype. Ignore pundits on CNBC that are, as it’s known in the industry, “talking your book”. In other words, they are promoting the stocks they own, hoping you – the individual investor – will push the price up for them. These stocks are almost always chronically over-valued.
Instead of buying the Wall Street darling, such as Square, in a growth industry such as payments, look for other companies in the same industry globally that are also doing well. Many of the fastest-growing payments firms are companies you’ve never heard of in places like Germany and Australia. And their valuations are about a quarter of Square because the Wall Street hype machine is not behind them.
DENNIS: I used to teach negotiations. One of the best negotiators I ever worked with was always cool, calm and collected. I asked him his secret.
His response was simple. “Dennis, the world is full of good deals if you are patient and willing to do your homework. The best way to turn a good deal into a bad one is to get emotional about it!”
Not only are your write-ups thorough, you never seem to get emotional. How do you do it?
TONY: First of all, I try to never let politics enter the investment equation. However, when politics can affect the global economy, such as ongoing trade disputes, you have to consider the consequences of such actions. The safest course in these instances is to prepare as if the worst-case scenario may happen (Wall Street does the opposite) and add insurance to your portfolio whether that’s gold, bonds or even some conservative stocks, such as consumer staples.
Next, I’m a Switzerland (neutral) when it comes to investing. I’m just trying to find the best stocks for my readers – that’s what subscribers are paying for, tapping my experience in the markets, which dates back to the 1980s. So, I don’t pigeon-hole myself into just looking at only tech stocks or even just U.S. stocks. I look for the best opportunities based on an ongoing global macroeconomic trend that I’ve identified, like the humanization of pet care which I mentioned earlier.
DENNIS: One final question. You are always looking at the big picture. With the economy booming, tariffs in full force, interest rates rising and an election coming up, there are a lot of factors affecting stock prices – in addition to how well a company performs. How do you factor in those types of influences?
TONY: The number one thing I do that is different from many investors and some other newsletter writers is that I always take a global perspective; not solely a U.S.-based perspective. That allows me to pick up early on macro trends. For example, if you don’t look at China, you miss much of what is happening in the move toward electric vehicles.
It also gives me perspective. For instance, many wonder why long-term U.S. interest rates are not rising. I believe the reason is substantial buying from overseas sources, not only because of geopolitical tensions but also because much of the developed world still has zero or negative (below zero) interest rates. Institutions such as insurance companies and pension funds need to earn a real return on their money.
DENNIS: Tony, on behalf of our readers, thank you very much.
TONY: My pleasure, thank you!
Dennis here. There you have it! All corporate earnings announcements should be suspect until proven otherwise. Diogenes would sure get frustrated looking for an honest earnings announcement. It’s one more area where investors must take the time to look behind the curtain for the facts before investing their money.
I have some good news.
Until next time…