Accountants change reporting rules - stock market soars!

Here's a modest proposal from another accounting professor, Edward Ketz, for fixing the economic slump. It's in keeping with what the Financial Accounting Standards Board (FASB) just did. Tell it like it isn't, and investors will swoon with excitement. Thanks to Paretta for this entry into the hall of fame for stimulus ideas.
Prof. Paretta's latest words of wisdom? Cash flows don't lie. Follow the cash flows. I'm trying to do that, but gosh, it's hard to know what all those "debt vehicles" are which gave Verizon lots & lots of cash in 2008. (Won't they have to pay it back some day?) Please, Paretta, help!

"Satyam is Sanskrit for Enron"

Prof Bob Paretta is back again with another lesson on reading financial statements. He shows that it's possible to spot corporate fraud using publicly available records before the market finds it or the company implodes. Remember Satyam? That Indian outsourcing company found with massive accounting fraud only 2 months ago? (See NYTimes article.) Here's Bob's Excel spreadsheet analysis of the cash flows and income statements that Satyam posted over the past 5 (count 'em, 5) years. (you'll need MS Excel to open it.) Paretta's Cash flow analysis for Satyam.

The gospel according to Paretta: "The spreadsheet shows an important accounting indicator -- the QofE (quality-of-earnings) ratio. It's the ratio of cash flow from operations to net income. Because net income includes non-cash expenses, cash flow from opns (CFO) should typically be higher than net income because to arrive at CFO you add back large expenses like depreciation and accrued expenses or expenses you did not pay for yet (Accts payable) and subtract smaller revenues that did not produce cash, like increases in Accts receivables. When CFO/NI is not greater than 1, it brings into question whether net income includes revenues that are being recorded before the're actually earned. (or even fictitious revenues!) So when QofE is less than one for even one period, it's a red flag and when it remains so over nearly a 5 year period, as in the case of Satyam, it is a big red flag! If you fictictiously inflate revenue then you also have to inflate accounts receivable; otherwise the accounts don't balance. Satyam's receivables rose steadily over the five year period and also as a percentage of net income. That relationship can jump around for a period or two (also a red flag) but when it grows steadily then you have to ask, why are they increasingly not collecting the revenues they are recording in A/R (big red flag). If you're a Satyam kind of company, if you want CFO to rise so that it exceeds or approaches net income you have to either stop paying your A/P or you have to make up fictitious A/P, because A/P reduces net income but does not affect CFO. Notice how on the second page of the spreadsheet A/R and A/P and related accruals are increasing and are an increasing percentage of net income? Again if it happens just one period, it is a blip on the radar...a pink flag. If it keeps happening, it is another big red flag. It means you are increasingly not collecting your A/R and you are not paying your debts. The conclusion is you are either a crook or you don't know how to run your business. So three big red flags and it is time to sell, call the cash flow police, or both. The mystifying thing is that Raju admits that 94%, or $1 billion, of the company's cash balance was fictitious. That should have been caught by the auditors (PwC) unless the banking system in India is so corrupt that banks sent PwC false confirmations. In any case Raju could not have done this alone. There had to be collusion on a massive scale to the extent we have never seen before. The international fallout from this is going to be huge. Stay tuned."
Yes we Can! (stay tuned, that is.)
Thanks again, Doctor Bob.

Seasonal Gifts from Doctor Bob

My oracle, Bobby P (U Del, Prof of Accting), has been sending me fun reads over the past month, and also fatherly advice.
Here is a fun & clickable viewing/reading list courtesy of Bob:

• The British comedy take on the meltdown -- from Bird and Fortune on YouTube. --really worth it.
• Michael Lewis (author of Liar's Poker) on how the whole CDO & CDS markets worked on the inside, in Politico.com
• Proof that the experts were not experts about the meltdown in USA Today. Bob quotes another Bob, the Marley,... "No experts...no cry."

Bob and other readers have sent additional very funny stuff, but some was dirty or I couldn't verify their sources on the web, & didn't want to inadvertently violate intellectual property rights. (Yes, lawyer Jeff, I DO listen to you!) Well, just one: What's the difference between an investment banker and a pigeon? The pigeon can still make a deposit on a Ferrari. Finally, in this season of peace and good will, I leave you with a few nuggets of fatherly advice delivered unto me by the good sage, Prof Paretta.

• "... avoid individual stock ownership and diversify through a low cost Indexed mutual fund like those offered by Vanguard - (S&P 500 fund, etc.)."
• "...the percentage of equities to fixed income investments should be 100 minus your age."
• "...remember Paretta's rule - In investing and war (and probably love too) the optimists suffer the largest casualties."
• "...be wary of expert opinions on what the market will do next unless they have a crystal ball that is still under a manufacturer's warranty."

So, until the end of the year, when I comment on comments, or until something new sticks in my craw, that's all folks.

The Lazy Girl's Guide to Cash Flow

Lazy about researching stocks you invest in? Me too, only worse. If I like the company name, or the product, or the industry (Yea, Solar!!! Go, baby, go!) I'll buy. I check out the stock's price history on yahoo, and maybe its price-earnings ratio and its dividend yield. If I have a couple of thou available and the stock price is cheap, I'll leap. This, as you can imagine, has led to some big embarassments, but never mind. Now, thanks to Bob Paretta (see previous post), I pledge that I will never ever ever buy a stock again without looking at the last three years' worth of net cash flow from operations (and in these times at the latest quarterly results, too). Turns out it's simple. Here's a step-by-step guide on how to do that.

1. Go to New York Times Business Page. In the right hand column, under the banner ad, is a section called "Markets.
2. In the box under "Get Quotes", enter the name or symbol of the company you want to look at, and press "go." Up comes a Times web page on your company.
3. Scroll down this page, and you will see, in the middle column, a heading called "Filings." Under this heading are the latest reports. 10-K is the most recent annual report. 10-Q is the latest quarterly report.
4. Click on the most recent 10-K report. This will automatically open up the report.
5. Go to Edit/"Find on this page" in the grey task bar on the top of the Internet Explorer window. Type in: "statement of cash flow" The cursor will take you to the first such mention in the document. Keep searching till you reach a table that shows the "consolidated statement of cash flows." Voila'! You've found it.
6. Just look at it -- 3 columns with the ins and outs of cash flows over the past 3 years. Relax, take a deep breath, maybe chant something like, "the 10-K is my friend." I guarantee that just looking at this table will help you make a decision about whether to buy or sell. (Whether it's a better decision is yours to find out. I certainly don't know.)

I'll let you know in an upcoming blog what I find out by doing this for Bank of America (symbol: BAC), and my home-town-upstate-NY love bug, Corning Class Works (GLW). Of course, Prof. Bob will be looking over my shoulder, I hope.

Looking at the Financials of Financial Institutions

I'm still burning over my stupidity in holding Wachovia stock through its long downward slide, while Professor Bob (Paretta, U Del) coulda done his cash flow analysis for me in time to make a difference, if only I'd been nicer to him. (See my post of Nov 3.) Now, P-Bob is playing Santa with backward looks at Lehman Bros and GE, the latter at my request.
For Lehman, the red flags were there for all the world to see in their 10-K filings. The sage Dr P. counsels me that "sometimes regulation is not enough, common sense has to play a role too. Even a Grandmother running a candy store would understand you can't remain in business if your reported income is positive and your cash flow is more than 10x negative." That's my problem! I'm a grandmother without a candy store!
Well, anyway, on to GE. This case, he says, is more complicated, cause it's a mixture of financial and non-financial operations. He says "quality of earnings" dipped but recovered, meaning that cash flow was better, relatively speaking. Dr. Bob told me to check GE's latest quarterly results for '08, (and he gave good directions on how to do this -- which I will share in my very next blog). I can report that for the 9 months ending Sept 08, cash flow was same as previous year's first 9 months, but net earnings dipped. Does that mean GE is just super-honest, letting its earnings fall but continuing to rake in the cash? Or is all this analysis of the distant past (i.e., anything before October '08) completely irrelevant to the future of a given stock? Please, Dr Bob! Help!

What Bob Paretta Coulda told me about Wachovia

This post should read: What Bob Paretta SHOULDa told me about Wachovia in time for me to sell it all on April 3, 07(price = 54.47), instead of when I did, Sep 22, 08 (price = 17.60).

Bob, (Prof of Accting at U Del) sent me the nice analysis at left to illustrate why I'm a dunce when it comes to the stock market. It's all about the cash flows, says he, and I believes him now. But not before I loses a pretty penny, says I. Bob also shared the two rules of Financial Analysis 101 that anyone who invests in the stock market should follow: Rule 1: Focus on the statement of cash flows. Rule 2: Pay attention to Rule 1. That's what you learns when u takes Bob's course in Accting 800.

Back when Bob and I taught at SUNY Binghamton, he was known among the faculty as "a river to his people." We were jealous but never knew why the students loved him so. Now I know.

Bottom line: Hold your friends close; hold your accountant friends closer!