GAAP is soooo silly!
Look at CELG!
GAAP earnings for the quarter were up 196% (from 25 cents to 74 cents).
Non-GAAP earnings were up 33% (from 76 cents to $1.01).
Which do YOU think gives a more realistic, more consistent, more reproducible, view of the growth of the business.
Just one of my favorite gripes.
Saul
GAAP has been totally corrupted by the government while Adjusted Earnings can be equally corrupted by management. Investor beware!
Denny Schlesinger
So Denny how do reconcile this? Do you go through the earnings and pick what you want to take out, trust management, go with GAAP, or use some other means?
Andy
So Denny how do reconcile this? Do you go through the earnings and pick what you want to take out, trust management, go with GAAP, or use some other means?
Andy
There is no hard and fast answer. It depends on the company or the type of company one is dealing with. Retailers are rather simple, insurance is rather complicated and for some development stage companies the Income Statement is irrelevant but the Balance Sheet isn’t.
My major beef with GAAP are the charge for stock compensation and the mark to market of warrants and similar financial liabilities. I don’t mind management backing out these two items. But I don’t like management backing out one time events specially when they have them every quarter.
One item I watch for is share count. Buybacks are meaningless when they just cover stock option grants – it’s a form of management scam.
For performance I look for revenue growth and margin expansion. In an ideal situation Net Income grows faster than Operating Income which grows faster than Net Revenue.
On the Balance Sheet the most important item is not to have excessive debt but an acceptable debt load depends on the industry. A company with loads of plant and equipment is justified in paying for it with debt. Not so a retailer that should be mostly a cash operation.
Like the song says: “You gotta know the territory.” https://www.youtube.com/watch?v=–RlTnxvLVo
Warren Buffett uses what he calls “owner earnings.”
Denny Schlesinger
The core lesson here is that dependence on any one reported number is likely to lead one into surprises as much as insight. Just taking the number as given is dangerous. And, it is not as if there are fixed adjustments one should make routinely since these depend on the industry, the individual company, and the circumstances of the time period. GAAP is well-intentioned and provides some guidance, but the devil is in the details.
My major beef with GAAP are the charge for stock compensation and the mark to market of warrants and similar financial liabilities. I don’t mind management backing out these two items. But I don’t like management backing out one time events specially when they have them every quarter.
Hi Denny, I agree. Those are my two major beefs also with GAAP. The idea that if a stock’s price drops during the quarter, GAAP reprices warrants to give the company higher GAAP earnings than the real earnings is just craziness. I don’t mind backing out one time events though if they are really one time (for example, extra legal and accounting costs for one or two quarters in setting up a big acquisition, is something that won’t be continued and is not reflective of the companies business). JMO
Saul
WARNING - LONG POST FOLLOWS - BUT THE NOTION OF ANALYSIS IS AT THE HEART OF INVESTING, I’VE GOT LOTS OF OBSERVATIONS AND QUESTIONS.
Denny,
Thanks - I’ve posted elsewhere that financial analysis is not one of my strengths. I’m pretty good at looking at a business operationally, but not financially.
It’s not the arithmetic, I can do that with my eyes closed, both hands tied behind my back and no calculator - it’s the damn financial statements. GAAP is intended to provide a consistent way of comparing apples to apples across all different businesses. This might be an inherently flawed concept to begin with. As Saul has pointed out more than once, GAAP reports frequently can and do lead to nonsensical financial performance indications for the reporting company. So then what? Industry specific GAAPs? What industry does Amazon belong to? Is it a retailer, a tech company, a media company or what?
So, we have non-GAAP. But there are no standards for non-GAAP. Every company more or less independently decides what comprises their non-GAAP reports. As Denny aptly pointed out, it’s easy to mislead via selective reporting. Stock buy-backs may hide compensation via stock awards. Ignored one-time events may have a way of occurring on a regular basis. Then you have a few companies like Solar City (I’m long) that invent their own metrics, what are we to make of them with no basis of comparison, benchmarks or whatever? There’s nothing that binds a company to even be consistent quarter to quarter with non-GAAP reporting. And, with both GAAP and non-GAAP reporting it’s easy for a company to hide very consequential financial information in the fine-print foot-notes.
And it shouldn’t surprise anyone to know that no company actually manages their business internally based on either GAAP or non-GAAP accounting statements. For sure, the suits (and occasional skirt) in the executive suite want these numbers to look good and be ever-improving, but internally the industrial engineers (or equivalent organizational body) operates to a whole different set of metrics that attempt to inform regarding the true state of business operations. Some of these numbers make it into financial reports, like sales/sq foot for a retailer, but most of them are well hidden from public view. For example, what’s the average turn around time (the time between a plane’s arrival at a gate until it departs from a gate on revenue flights) for a given aircraft type for a specific airline? You don’t know because it’s not reported, but every airline knows what it is for their operations. If this were reported, how would it influence your investment decision (or maybe you’re like Bob Crandall, former CEO of American Airlines who once said - I paraphrase - you have to be nuts to invest in an airline, I’m long VLRS).
I don’t have a solution for any of this. Like I said at the outset, financial analysis is not my strong suit. The math is simple. Spotting a developing trend can be a little tricky, but still not too difficult.My problem is knowing what to look for.
My financial analysis tends to be very simplistic. What’s the P/E? Has the company been growing earnings consistently? How much cash do they have? What does the free cash flow look like? How much L/T debt do they carry? Do they pay a dividend, for how long, does it go up regularly? I know, lot’s of debate about the merits of paying dividends, but it’s awfully hard to play games with this number. Sometimes I might look at growth in inventory as compared to sales, but that’s getting pretty sophisticated in my book. Generally, I view growing inventory as a bad thing irrespective of other factors.
How do I make investment decisions you might ask? Fair question. First, I don’t ignore financial analysis, I just recognize that I’m not very good at it so I read what I consider to be trusted sources have to say. If they seem to think things are peachy, I tend to just give a cursory review of the things I just set forth.
But mostly I try to look at what does the company do, how do they do it, what’s the perceived market and what sets them apart from the competition. I also try to be aware of my own biases and try not to let them play too much of a role in my decision process.
Last thing first - I’m kind of a techy by nature, so I I try to guard against getting too enthused about tech companies. Look at TMF, it’s an internet company, and these guys seem to love other internet companies, I think it’s a bias they have which sometimes overrides a thorough scrutiny of some of their recommendations. Linked In, Zillow, Twitter, Facebook, Trip Advisor, Pandora, Priceline, Amazon, Netflix, BofI among others - While I’m long on a few of these, TMF has a long list of internet based companies I’m not so sure about. I think Dave and Tom have a blind spot here.
I try to be aware of Glass Door employee ratings. Why is that important? In my opinion a company that holds their employees in low regard is likely to treat their customers in a similar manner. I would never invest in Walmart or MickyD. You might disagree with me, fine, I’m just telling you what I pay attention to.
Also, companies sometimes tell lies to investors when they squeeze their employees. I worked at Boeing under 5 different CEOs (6 if you include interim CEO, James Bell), in order, they were T. Wilson, Frank Schrontz, Phil Condit, Harry Stonecipher and Jim McNerney (as an aside, Jim and I went to the same high school, he was certainly not the brightest bulb at New Trier). The first three of these guys treated the employees pretty well (despite some pretty brutal union battles). In general, benefits were improved under each of them. Under the last two guys, benefits were taken away and more and more was demanded of fewer people (in simple terms, off the clock labor became the norm for salaried payroll). But, company reporting indicated that Boeing was improving productivity. That was a bald lie. Cutting costs by reducing benefits and demanding unremunerated labor does not reflect productivity improvement. No business operation has been improved, no efficiency improvement has been realized, no process has been made more effective. What has occurred is that a tangible cost (e.g. elimination of educational benefits, pay for hours worked) has been traded for the intangible cost of reduced employee morale. Lynch said it’s good to invest in a company even an idiot could run because sooner or later one will - I sold my Boeing stock. Two idiots in a row, especially when Mulally was such an obvious choice makes you stop and wonder if members of the board are all idiots. Sorry, I guess that was a bit of a rant . . .
How can I evaluate a business without making the financials my primary concern? Well first off, I think financials are inherently short term. They focus on the next quarter or the next year, but they don’t really tell you about the business. I got in a discussion on this board about TCS and how I just don’t see it as a viable investment. Maybe the management can open more stores and grow the company but IMHO the business has no way to sustain itself. How many special boxes can you sell? I can’t see the market going anywhere in the long run . . .
I’ll try and let Jack Ma tell the story. If you don’t know who he is, he’s the founder and CEO of Ali Baba. He’s 51 years old. A former English teacher and now the richest man in Mainland China, and probably vying with Gates, Buffet and a few others for richest guy in the world.
I read this years ago, so I may not have it exactly right, but Jack Ma was once asked about his business priorities. He did not have to ponder the question. First, operate within the law. Whether you like the law is irrelevant. If you operate outside the law, you will eventually be caught and then have no business (this imperative seems to have been lost on our too-big-to-fail banks). Second, always treat your customers with respect and strive to exceed their expectations. This should be obvious, if your customers leave you, you will soon be out of business. Next, choose your employees wisely and treat them fairly and respectfully. You can’t know everything you need to know and even if you did, you can’t do everything that needs to be done. Make sure your employees can. And, if your employees are unhappy, the unhappiness will be realized by the customers. Further, low morale is equivalent with low productivity. There is no substitute for enthusiastic employees. Here’s where I get a little fuzzy, but I think the next thing had to do with treating members of the supply chain with honesty and integrity. Then I think he addressed responsibility to the community and environment. And last came the investors. Jack asserted that the investors always had the most demands and were always the first to jump ship with the slightest sign of trouble.
As an investor, you may take offense to this, however, if you’re in it for the long haul then this set of priorities should make you happy. But, if you look over that list, there’s not a single thing in it that directly addresses growth or financial performance. It’s all about how to run a successful business in five +/- not-so-easy steps. Mr. Ma asserts that if you run your business by the right principles, the financial stuff takes care of itself. Of course, the luck of being in the right place at the right time with the right idea doesn’t hurt either.
BTW, I don’t hold BABA. I don’t have a good reason. They went public a few months ago at $68, they’re now at $89 (fell 8+% yesterday on an earnings miss. That sudden drop in the stock price is exactly the kind of short-term investor commitment Mr. Ma addressed in his business priorities). Jack has a goal for Ali Baba to be in business at least 102 years. Why 102 years? They were founded in 1999, 102 years will allow them to claim continuous business operations in three separate centuries. Name another company with that kind of long-term vision and commitment?
Brittlerock,
Your excellent post reminds us that successful investing involves choosing companies with exceptional people as employees. And choosing companies with leadership that show old fashioned character qualities such as honesty and integrity that can motivate employees to treat the customer as king.
I have found in my small private dental practice of 40 years that the key to my success has been finding and retaining long term employees that have that rare and under rated quality of joy and enthusiasm for their work and a genuine love of the customer that they serve.
Larger operations that come to mind that exemplify these qualities are Apple and Southwest Airlines. There really is something to that “Southwest Spirit”. No matter now silly my questions are, when I call Apple for help with my laptop or I Phone or Notebook, I am treated with dignity and respect. That has resulted me loyally buying Apple products year after year, knowing that when I need help there will be an unfailing friendly enthusiastic person that will help me in minutes. Long term, those “little people” will determine how successful the company will become and what kind return my investment will be.
Yes, I also concur that long term investing is more than simply numbers and analysis. Long term, great numbers come with great people of character in any operation.
Jim
brittlerock, a most excellent post! For background, I started out in Data Processing (now IT) with IBM which put me in contact with many varied businesses. Later, at NCR, they had me learn accounting. After seven years as a corporate employee I became an independent management consultant for the next ten years. Many in my family of my parent’s generation were business owners. This background let’s me look at businesses as both owner and investor, not the same thing. Many so called investors are traders or speculators. I don’t say this in a derogatory manner at all. I recognize that there is a “business universe” populated with all sorts of species we call owners, investors, traders, speculators, buyers, sellers, suppliers, bosses, employees, regulators, analysts, market makers, lenders, borrowers, and many other kind of whatnots including Fools. There is a new science that studies these universes called the Science of Complexity.
Today’s POD is an interesting counterpoint: Fool Me Once… The author simplifies the complex universe I describe above to a single metric, the “Q Ratio.” What are the chances that a single number can foretell the future of a complex system. About nil.
http://caps.fool.com/Blogs/fool-me-once/1034570
Before you can decide how to follow the business you have to find out what role you are playing: “owner, investor, trader, speculator or hanger on.” Let me use Saul and PFIE as an illustration (not a judgement). Saul decided on his own to buy PFIE: Not a hanger on. Saul sold as soon as the stock dropped: Not an owner. Saul is somewhere between investor and trader where PFIE is concerned. We can play different roles with various companies and stocks. Maybe “high conviction” shifts your role from trader to investor.
Each role relies on different tools. Many successful traders don’t want to hear any news, they just look at charts, three and six month charts being favorites. Value investors want to dig deep into all the available data.
CEOs also play roles. At IBM the Watsons were owners. The next set of CEOs were professional managers and the difference showed. Then came a trouble shooting consultant to turn things around. Jobs got fired from Apple for being an overbearing owner. He learned some important lessons while wandering in the wilderness and came back as a much better owner. Buffett is an owner at Berkshire Hathaway but an investor in the rest of the conglomerate. BTW, most of us cannot play the role of owner in the market despite the admonition from people like Buffett to do so. We simply don’t have the power and influence to do so.
To sum up, first know yourself, then know your businesses or investments.
Denny Schlesinger
Interesting thoughts Denny. I agree - Nil.
I want to chime in on Q ratio, I think we all would like to have a simple numerical indicator that tells us to invest or not ( at least we THINK we do, but that is another discussion). And from time to time various numbers become the “It” number. I can remember waiting to hear releases of the M1, and M2 numbers from the Fed, for example. I just don’t think that investing is that simple. And let us not forget Long Term Capital Management- get all those bright MIT Phds in a firm and turn the quants loose to manufacture market profits. If Tobin, Smithers et al are so smart, where are their billions? The Q ratio was developed in 1969, there has been plenty of time to generate outsized returns to back up the theory. Smither’s book made a good call once, but the test is someone putting it into practice over a long period of time and having success.
For all of you too young to remember Initially successful with annualized return of over 21% (after fees) in its first year, 43% in the second year and 41% in the third year, in 1998 it lost $4.6 billion in less than four months following the 1997 Asian financial crisis and 1998 Russian financial crisis requiring financial intervention by the Federal Reserve, with the fund liquidating and dissolving in early 2000. http://en.wikipedia.org/wiki/Long-Term_Capital_Management
I am glad I was not required by the Fed to put up capital to save the world from the folly of academics in the markets… Ah program trading, I remember you.
So when an academic starts telling you how to invest remember- Run Away! and Ask the important question “where are the academic’s yachts?”
The academics behind LTCM may not have got billions out of LTCM before it went bust but they got several million each. Maybe they didn’t do as well as the executives of banks bailed out by our tax dollars but they still did pretty good for themselves.
You only get in trouble managing other people’s money if you do a Ponzi or other felony.There are all those management fees, yours to keep. Unless you were dumb enough to invest your money in the same places as you put the investors money.
“where are the academic’s yachts?”
A most excellent question!
Denny Schlesinger
brittlerock, a most excellent post!
Thanks Denny, I appreciate that you took the time to read the post after having been warned that it was rather long.
I had to recommend this post.
This whole discussion is why I enjoy reading MF
I am usually not one person who posts a lot because I think I do have much to offer, though I am following the posts with keen interest.
Enjoy the Super Bowl today, Erik
Seeing as this is my first post on this board, allow me a brief introduction. I am a CPA, but practicing in income tax rather than financial statements. I try to keep aware of the issues my financial statement preparing colleagues face, but I’m not an expert in them. However, I do think my personal distance from the day to day issues gives me the freedom to think in broader terms.
GAAP is intended to provide a consistent way of comparing apples to apples across all different businesses.
That is the way GAAP started out. But it has morphed over the years into a grotesque monster. And the upcoming IFRS aren’t much better.
At its core, accounting is an attempt to present the financial performance and position of a business so that management and investors can make intelligent and informed decisions about the business. Income is reported when earned, expenses reported when incurred, assets and liabilities of the business fully disclosed.
The problem is that management always has more information about the business than investors. And management is the one that prepares financial information for the investors to use. So it becomes easy for management to mislead investors about the finances of a business.
Many of our current accounting pronouncements are nothing more than a reaction to a problem (usually a fraud by management) that has arisen at some company. If you follow all of the big frauds over the years, you’ll usually find some new accounting rule following the fraud that is an attempt to keep that fraud from happening again.
I call that “legislating morality”. And you simply can’t write laws and rules that cause people to behave morally. Morality and fairness don’t arise from laws, they arise from within the individual. Laws and rules simply allow society to define behaviors that will be punished in some way.
So applying this to financial statements, we get back to the issue of management vs. investors. Investors are entirely reliant on management for their financial information. GAAP and IFRS cannot create fair financial reporting, they can only identify unfair reporting when that particular unfairness has happened before. Dishonest management will create dishonest reports. Honest management will create honest reports.
What does this say about GAAP vs. Adjusted Earnings? It says we need to look at management first. Financial reports that follow GAAP don’t necessarily give a good picture of a business, they simply follow the rules laid down by GAAP. Adjusted earnings (or adjusted anything) can be a good thing when honest management is attempting to give investors a more complete picture of the business than can be conveyed in GAAP financial statements. But adjusted earnings can be used by dishonest management to cover up problems.
So I’d say the first step in evaluating a business is not to look at their finances, but to look at their management. Honest management will give honest financial statements. Dishonest management will give investors dishonest financial statements - even if those statements follow GAAP. When you find dishonest management, move along. You will never be able to fully trust information coming from that company.
GAAP vs. Adjusted earnings? Bring on the adjusted earnings. But before I put any faith in either, it is up to me as an investor to do my due diligence work on management.
–Peter
Seeing as this is my first post on this board, allow me a brief introduction. I am a CPA, but practicing in income tax rather than financial statements. I try to keep aware of the issues my financial statement preparing colleagues face, but I’m not an expert in them. However, I do think my personal distance from the day to day issues gives me the freedom to think in broader terms. GAAP is intended to provide a consistent way of comparing apples to apples across all different businesses. That is the way GAAP started out. But it has morphed over the years into a grotesque monster. And the upcoming IFRS aren’t much better. At its core, accounting is an attempt to present the financial performance and position of a business so that management and investors can make intelligent and informed decisions about the business. Income is reported when earned, expenses reported when incurred, assets and liabilities of the business fully disclosed…
Wow, Peter, what a great discussion from the point of view of a CPA!!!
Thanks so much.
Saul
For FAQ’s and Knowledgebase
please go to Post #5584
So I’d say the first step in evaluating a business is not to look at their finances, but to look at their management. Honest management will give honest financial statements. Dishonest management will give investors dishonest financial statements - even if those statements follow GAAP. When you find dishonest management, move along. You will never be able to fully trust information coming from that company.
GAAP vs. Adjusted earnings? Bring on the adjusted earnings. But before I put any faith in either, it is up to me as an investor to do my due diligence work on management.
–Peter
Peter, you are absolutely right! If you don’t trust management move along. Neither GAAP nor kumquats will protect you.
Denny Schlesinger
I seem to be incapable of short succinct posts. Here’s another long rambling collection of thoughts about accounting, analysis, evaluation and investment decisions.
Many of our current accounting pronouncements are nothing more than a reaction to a problem (usually a fraud by management) that has arisen at some company. If you follow all of the big frauds over the years, you’ll usually find some new accounting rule following the fraud that is an attempt to keep that fraud from happening again.
Absolutely too true. I assume everyone reading here remembers the Enron debacle. A company with management so corrupt that G. W. Bush had to find another mode of transportation during his first campaign for POTUS because it was too embarrassing to be seen flying around in the corporate jet his good ol’ buddy Ken Lay had put at his disposal.
From this came the much ballyhooed Sarbanes-Oxley legislation, which was going to end corporate fraud. For Good. For Ever.
What ensued was a black comedy if anyone was paying attention. I worked at Boeing in IT at the time. The executives at Boeing reacted with a vengeance. At its heart, SoX (as it came to be known - gotta love acros, which is an abbreviation, an acronym if you will for acronyms) was accounting legislation. What made it a little different from most is that it held the CEO and CFO of publicly traded companies personally responsible for certain aspects of the publicly filed financial statements with enforcement penalties which included personal fines and JAIL time. Now, that got the attention of the C-suite.
So, what did these executives do? They turned to their accountants and asked, “What should we do in order to comply? We can probably cough up some hard earned bonus money, but we really, really want to stay out of prison, even country club prison.” Boeing was not unique, this cut across virtually the entire corporate world.
And what did the accountants tell them? They (looking at SoX as if it were manna from heaven) told them, “You must enshrine thine systems of account. They must be made invulnerable from tampering, each and every sacred number therein must be of known origin, and must be surrounded by a prophylaxis which insulates it from fudgement. For fudgement of numbers is unholy and a sin per the congressionally divine written words of the SoX.”
Why was this such a blessed event for accounting firms? Well, all of them (that would be 100%, for the big ones anyway) have a very lucrative IT consulting business either directly under their corporate umbrella, or closely associated with it. There was more than a wee bit o’ irony that Accenture made a great deal of hay from SoX. You see, Accenture had not too long before been spun off from Arthur Andersen, the accounting firm driven to demise for destruction of Enron evidence under direct order of home office officers.
So, SoX became an IT project at Boeing and just about everywhere else. Us IT guys were ever so busy changing applications and databases and processes to ensure a “chain of accountability” for all the sacred numbers contained therein. No number could be altered without knowledge and traceability to the source of the alteration. And after many hours of overtime and frequent status collecting, summarizing and reporting all the way up to the CIO and even to the CEO and CFO, SoX, to a collective sigh of relief was implemented - and our independent accountants would attest to it. And with this sworn testimony, the CEO and CFO signed off on it.
But wait just a minute - What actually happened at Enron? Did all of the “Smartest Guys in the Room” actually manipulate the sacred numbers of the accounting systems by making unauthorized changes? Did they secretly alter the holy numbers in order to depict false fabulous financial performance?
Nah, not at all. Not a single computer system was manipulated in any way shape or form. No data entry process was deviously manipulated. All the financial reporting systems faithfully reported on shell operations set up to hide the actual conditions of the business. Enron’s energy contract manipulations were all part and parcel of the recently enacted deregulation in the energy supply business, it had nothing to do with falsifying the data once entered in the financial computing systems. In fact, none of Enron’s sins, illegal or just immoral had anything to do with nefarious computing system activity. No executive crept into the server room in the dead of night and messed about with a database. And oh yeah, all the irregular financial activity was sworn to be a faithful and accurate representation of the business via the testimony of their “independent” accountants.
But, the accepted reaction to SoX was all about “fixing” the computing environment.
But my naive view is that liars lie.
And there are few things that make lying easier than numbers because they seem so inviolable. Rene Descartes (the 17th century French mathematician, scientist and philosopher, often referred to as “The Father of Modern Philosophy”, the guy responsible for the Cartesian coordinate system) developed an entire philosophical thesis on the indisputable fact that 7 + 5 = 12 (or was it 5 + 7, I’m not sure).
Numbers do not lie. Liars lie.
And this is why I look first at the business and the businessmen (and occasional businesswomen) before I cast an eye at the financial reports when I make investment decisions. If I have a strong sense of the business operations, prospects and management and subsequently observe support in the financial reports I might invest.
Earlier in this thread (post 5506) I cited Jack Ma’s observations about business priorities. I noted that he made no direct mention of sales, earnings, debt, costs or any financial information that could be numerically quantified. He talked about how to run a successful business.
I also noted that I’ve not invested in BABA - I probably won’t. Though I have a lot of respect for Mr. Ma, I also have a lot of experience with China. I used to invest in Chinese companies, but as my direct knowledge of China has grown, my enthusiasm for Chinese investments has waned. My wife is Chinese and I spend considerable amounts of time there.
China has a very different culture. If you study history you will find that the Chinese in many ways invented capitalism and international commerce. There is a lot of evidence that the Chinese visited the Americas more than 50 years before Columbus and circumnavigated the globe several years before Magellan/Elcano. For the Chinese, it was basically a trade mission. Anyone who thinks China is a communist country has no idea of the current reality. The communist experiment was a short-lived aberration. But that being said, the Chinese approach to business is just different than the way we understand it in the West. Westerners think of business as a shared ownership enterprise. Holding stock is the expression of and the degree to which we participate in this sharing engagement. It’s all well defined in codes of law.
The Chinese (IMHO) think of business as a family affair. It may not be all blood relatives, but there remains a relatively small group of participants who are part of the family. Stock is a device (borrowed from the West) for raising capital, but the stockholders are not members of the family and never will be. Business decisions ultimately revolve around the betterment and protection of the family. Often, those decisions align with the best interests of the stockholder, but if not, there is not even a passing notion that some trust has been violated. This is a matter of morality, it’s just that the basic understanding of what constitutes a moral judgement and action is different in China than it is in the West.
There are other fundamental cultural differences that deeply influence the conduct of business. In the West, we generally view the exchange of gifts and favors as bribery. In China their is an elaborate system of balance in personal relationships known as “quanxi”. It can be very hard to discriminate between the moral demands of quanxi and outright corruption.
And the Chinese legal system is primitive, ill-defined, amorphous and poorly and inconsistently enforced by Western standards.
I could go on, but this board is not about the history and culture of China. I’ll leave it with the admonishment that proceed with lots of caution if you chose to invest in a Chinese company. There are great opportunities in China at present, you could make a lot of money. But there is an element of risk that is based on deeply ingrained cultural attitudes and behaviors. It won’t show up in the financial statements or the TMF 25 question risk assessment tool.
Returning to the subject - This is just one more caution regarding accounting, GAAP or other. As posted by Peter:
GAAP vs. Adjusted earnings? Bring on the adjusted earnings. But before I put any faith in either, it is up to me as an investor to do my due diligence work on management.
So don’t look to legislation to provide honesty and integrity. And you’d best know at least a little about the culture if you chose to invest in a foreign enterprise as well. Not for a moment do I mean to suggest that the Chinese (or any other people) are inherently dishonest, I’m only suggesting that the very definition of what constitutes a moral action is culturally dependent.
I seem to be incapable of short succinct posts. Here’s another long rambling collection of thoughts about accounting, analysis, evaluation and investment decisions.
Thanks for sharing, BrittleRock. I agree with your assessment of the Chinese attitude toward stockholders who are not part of the “family” and also agree with you that it’s not dishonesty, it’s just a totally different idea about what is acceptable and “normal” behavior (which is why I won’t invest again in ANY Chinese company. Been there. Done that.
Saul
Great input Peter. Do you have some hints on how you due your DD on management and how far you go down the totem pole.
Thanks
BGM