As I mentioned last week, I'm working on some screens directed toward finding companies that may be playing some type of accounting shenanigans. My ultimate goal is to select a company and write a report about it. While I have some ideas about where this could lead, I'm not ready to share them yet, as I'm still thinking things through. I'll be looking at some issues I've written about in the past. I have all my old articles indexed, so where applicable I'll provide references. Since my recent track record of keeping in touch has been less than stellar, I'm not going to commit to anything specific in terms of a plan yet. I'll get things started, see what kind of responses I get, how the discussion goes, how many new Fools we bring in, etc.I'm using AAII's Stock Investor Pro to run my screens. I'll talk about my criteria in general terms, but at least for now, I won't provide specifics on what I'm looking for in terms of magnitude.Here are the elements I'm going to focus on at least for now.Comparison of cash flow from operations to net income. Cash in the door is more relevant than net income which is affected by all kinds of accruals. There have been a number of papers written (see, for example, the works of Richard Sloan "Information in Accruals About the Quality of Earnings" http://papers.ssrn.com/sol3/papers.cfm?abstract_id=278308 discussing how significant accounting accruals (inventory and accounts receivable are included in accruals) can have a negative effect on stock performance.Growth in accounts receivable and inventory relative to sales This article was one of my all time favorites: http://www.fool.com/portfolios/rulemaker/1999/rulemaker991102.htm. For screening purposes, we can either use the cash conversion cycle or the simplified version which just involves looking at growth rates in sales, receivables, and inventory.Growth in debt (preferred stock will be included with debt) See http://www.fool.com/portfolios/rulemaker/1999/rulemaker990804.htm, http://www.fool.com/portfolios/rulemaker/1999/rulemaker990831.htm, and http://www.fool.com/portfolios/rulemaker/1999/rulemaker990901.htm for a discussion of debt types.The above are relatively easy to screen for. I also plan to look at some things that will require digging into the financials--stock options (http://www.fool.com/research/2000/features001228.htm and http://www.fool.com/portfolios/rulemaker/2001/rulemaker010807.htm), including unfettered free cash flow http://www.2ndopinionresearch.com/, off-balance sheet debt (e.g., operating leases), and pension accounting.I hope that I've at least piqued some interest. If so, I look forward to finding out where this leads.Phil
This is the piece of the puzzle that convolutes a balance sheet.and pension accounting.I hope that I've at least piqued some interest. If so, I look forward to finding out where this leads.PhilFASB accounting is pretty complex and is full of assumptions that can come back and bite "hard" when LT assumptions aren't met. I've got an accounting explanation on my system in the form of a 65 page pdf report if you want it? Let me know. Don't want to complicate your screen, but pensions are going to be a big issue for the next 5-10 years, imv.KBM (aka "The Other BB - tm")
You're right. Pension accounting is pretty complex as is its less publicized partner health care expenses. Both are full of assumptions that can easily be manipulated to make earnings look better. Unfortunately, my software doesn't allow me to screen for anything on pensions. I can only find that info by digging into the footnotes. The earnings assumptions, growth and discuount rates used are usually unrealistic. Companies can use either side of the equation to their benefit. It's more of an issue for older firms than newer ones. The rise of defined benefit 401(k) plans makes the issue less relevant for newer companies. The issue comes around defined benefit plans. The Analysts Accounting Observer (subscription only) has some great data on this issue for S&P 500 companies.A portion of the Level 2 CFA curriculum was directed toward pension accounting. I've read a number of papers on the subject but would be happy to take a look at yours if you don't mind forwarding it (email@example.com. I can always find something that I might not have thought of when I review a new perspective.Phil
Phil,In terms of CFA, how do you factor in a company buying back shares? KO and MSFT do this all the time. I own both stocks (I'm concerned whether I should hold on to KO since their earnings and growth have been ahem less than stellar, there are other things such as their goodwill payments to CCE that are hurting earnings as well, but that is for the KO board).Thanks,Stymie
how do you factor in a company buying back shares? KO and MSFT do this all the time. I own both stocks (I'm concerned whether I should hold on to KO since their earnings and growth have been ahem less than stellar, there are other things such as their goodwill payments to CCE that are hurting earnings as well, but that is for the KO board).There are a couple of things you can consider when it comes to share buybacks. First, is the company actually buying back shares, or is it just trying to benefit its stock price by making a buyback announcement? You also should look at what's happening to the diluted share count. Companies that issue lots of options (Cisco is a great example here) buy back tons of shares to cover their option overhang. But, the share count doesn't go down all that much. So, what's really happening is that they're transferring money to their employees in the form of share buybacks. You can check the investing section of the cash flow statement for some info on share buybacks. For example, in its most recent 10Q, Cisco shows that it used 3,001 million of cash to buyback shares and received 96 million from stock issuance. Additional information on buyback activity can be found in the Statement of Shareholders' Equity. I'm happy to discuss this more if you have further questions.As for Coke and its payments to bottlers, be careful about that. Coke and its bottlers are related parties. There are still some shenanigans that can be played with those payments. (See: Accounting at Coke http://www.fool.com/CashKing/1998/CashKingPort981008.htm).The lack of fair value information in financial statements does mean that the intangibles are not fully reflected on the balance sheet. In the case of a company like Coke, they can have significant value.I probably won't be posting again until after Thanksgiving. I hope that everyone has a good holiday.Phil
I think you left out another important consideration, i.e. are they buying back shares above or below intrinsic value.
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