Food for thoughts on investing in undervalued companies

Again, I had a rather long break. And I'm back. One of the cornerstone to successful investing is to buy undervalued businesses. But is it enough? I'd argue it ain't. One other aspect is to have good management that really thinks and acts in the right manner on the behalf of the shareholders, whom the management ultimately have a fiduciary responsibility to.

Sometime in July 09, IMS Health was selling at $12 - click here for more details in a previous post. At $12, the whole company was selling for $2.2 billion. A value that substantially undervalues the company in relation to its future earnings potential. This week, a consortium led by TPG offered $4 billion (or $22 a share) to buy out IMS. The offer was accepted by IMS management. David Carlucci, IMS Chairman and CEO, said: "This transaction enables our shareholders to realize substantial value from their investment in IMS with an immediate cash premium." But is it really so?

Yes, it is but with a caveat. It only offer substantial immediate value for those shareholders who had bought at $12 or so during the period in July but not for the other shareholders. In effect, the management had sold out on the majority of its shareholders. During the period between Oct 08 to before the offer, its share was traded in the range of about $10 to $18 (mostly at $12). Only shareholders who had invested during this period had benefitted but not fully - substantial value is left on the table.

Prior to Oct 08, its share traded at above $22. At that price, it too was undervalued in relation to what a full price would be. At $22, the whole company sells for $4B, with a free cash flow of over $350 million. The company is holding up well through the crisis and business prospects appear sound, though revenue had declined. Expanding global pharmaceuticals market, as expected by IMS, to grow at a compound rate of 4 to 7% to about $1 trillion in 2013. So what value, if any, does TPG and its partner bring to the table. Indeed, much value is left behind.

In my view, the management had failed in its fiduciary responsibility to its shareholders. Even for investor who bought at $12, they may have less cause for celebration because the management failed to do their best to get a full value of what the company is really worth. One reason the management is eager to sell could be because of the generous slice of equity in the deal they can get.

So in essence, even if an investor manage to find an undervalued company (imagine you had bought IMS at $22 which is an undervalued price), they may not get rewarded because of a mediocre management.

On the other hand, it is always better to invest in a company that is not only undervalued, but comes with a decent management (think of Berkshire, YUM Brands, Amex, Wells Fargo) who takes care and thinks for their shareholders whom they represent. However, if an opportunity comes where a company is undervalued but its management is mediocre, it's best to buy only at a substantially undervalued price, for IMS case, it did be at $12 or so, not $22 - though both prices are undervalued. Any value investor who had bought before Oct 08 at $22 would perhaps rethink about the whole concept of buying into a company that is run by people who do not think for the people they represent.

NYT: Closely Watched Buffett Recalculating His Bets

Published September 8, 2009

Warren E. Buffett has two cardinal rules of investing. Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1.

Well, a lot of old rules got trashed when the financial crisis struck — even for the Oracle of Omaha.

At 79, Mr. Buffett is coming off the worst year of his long, storied career. On paper, he personally lost an estimated $25 billion in the financial panic of 2008, enough to cost him his title as the world’s richest man. (His friend and sometime bridge partner, Bill Gates, now holds that honor, according to Forbes.)

And yet few people on or off Wall Street have capitalized on this crisis as deftly as Mr. Buffett. After counseling Washington to rescue the nation’s financial industry and publicly urging Americans to buy stocks as the markets reeled, in he swooped. Mr. Buffett positioned himself to profit from the market mayhem — as well as all those taxpayer-financed bailouts — and thus secure his legacy as one of the greatest investors of all time.

When so many others were running scared last autumn, Mr. Buffett invested billions inGoldman Sachs — and got a far better deal than Washington. He then staked billions more on General Electric. While taxpayers never bailed out Mr. Buffett, they did bail out some of his stock picks. Goldman, American Express, Bank of America, Wells Fargo, U.S. Bancorp — all of them got public bailouts that ultimately benefited private shareholders like Mr. Buffett.

If Mr. Buffett picked well — and, so far, it looks as if he did — his payoff could be enormous. But now, only a year after the crisis struck, he seems to be worrying that the broader stock market might falter again. After boldly buying when so many were selling assets, his conglomerate, Berkshire Hathaway, is pulling back, buying fewer stocks while investing in corporate and government debt. And Mr. Buffett is warning that the economy, though on the mend, remains deeply troubled.

“We are not out of problems yet,” Mr. Buffett said last week in an interview, in which he reflected on the lessons of the last 12 months. “We have got to get the sputtering economy back so it is functioning as it should be.”

Still, Mr. Buffett hardly sounded shellshocked in the wake of what he once called the financial equivalent of Pearl Harbor. (An estimated net worth of $37 billion would be a balm to anyone’s psyche.)

“It has been an incredibly interesting period in the last year and a half. Just the drama,” Mr. Buffett said. “Watching the movie has been fun, and occasionally participating has been fun too, though not in what it has done to people’s lives.”

Investors big and small hang on Mr. Buffett’s pronouncements, and with good reason: if you had invested $1,000 in the stock of Berkshire in 1965, you would have amassed millions of dollars by 2007.

Despite that formidable record, the financial crisis dealt him a stinging blow. While he has not changed his value-oriented approach to investing — he says he likes to buy quality merchandise, whether socks or stocks, at bargain prices — Buffettologists wonder what will define the final chapters of his celebrated career.

In doubt, too, is the future of a post-Buffett Berkshire. The sprawling company, whose primary business is insurance, lost about a fifth of its market value during the last year, roughly as much as the broader stock market. While Berkshire remains a corporate bastion, it lost $1.53 billion during the first quarter, then its top-flight credit rating. It returned to profit during the second quarter.

Time is short. While he has no immediate plans to retire, Mr. Buffett is believed to be grooming several possible successors, notably David L. Sokol, chairman of MidAmerican Energy Holdings at Berkshire and also chairman of NetJets, the private jet company owned by Berkshire.

After searching in vain for good investments during the bull market years, Mr. Buffett used last year’s rout to make investments that could sow the seeds of future profits.

Justin Fuller, author of the blog Buffettologist and a partner at Midway Capital Research and Management, said the events of the last year, while painful for many, provided Mr. Buffett with the opportunity he had been waiting for.

“He put a ton of capital to work,” Mr. Fuller said. “The crisis gave him the ability to put one last and lasting impression on Berkshire Hathaway.”

For the moment, however, Mr. Buffett seems to be retrenching a bit. Like so many people, he was blindsided by the blowup in the housing market and the recession that followed, which hammered his holdings of financial and consumer-related companies. He readily concedes he made his share of mistakes. Among his blunders: investing in an energy company around the time oil prices peaked, and in two Irish banks even as that country’s financial system trembled.

Mr. Buffett declined to predict the short-run course of the stock market. But corporate data from Berkshire shows his company was selling more stocks than it was buying by the end of the second quarter, according to Bloomberg News. Its spending on stocks fell to the lowest level in more than five years, although the company is still deftly picking up shares in some companies and buying corporate and government debt.

Among the stocks Mr. Buffett has been selling lately is Moody’s, the granddaddy of the much-maligned credit ratings industry. Berkshire, Moody’s largest shareholder, said last week that it had reduced its stake by 2 percent.

The shift in Berkshire’s investments suggests Mr. Buffett is starting to worry, said Alice Schroeder, the author of “The Snowball,” a biography of Mr. Buffett.

But Ms. Schroeder said Mr. Buffett was also growing anxious about how he would be remembered. He wants to remain relevant in the twilight of his career, she said, and is taking a more prominent role on the public stage. That shift means ordinary investors are getting a chance to hear more of his sage advice, but it also carries some risk.

“Before, he always made sure to dole out the wisdom with an eyedropper,” Ms. Schroeder said. In the past, Mr. Buffett “said it was a mistake to believe that if you are an expert in one area that people will listen to you in others,” she said.

Whatever his recent missteps, many people, from President Obama down, listen to what Mr. Buffett has to say. He is important in his own right as a billionaire businessman but also because millions of ordinary investors follow his homespun aphorisms, copy his investing strategies and await his pronouncements on the markets.

Mr. Buffett refused to be drawn out on where stocks are headed, but he warned about the dangers of investing with borrowed money, or leverage, which proved disastrous when the crisis hit.

As for regrets, he has a few. His timing was bad, he concedes. He should have sold stocks sooner, before the markets tumbled. Then he served up a Buffettism that any investor might heed:

Asked if anything was keeping him awake at night, he said there was not. “If it’s going to keep me awake at night,” Mr. Buffett said, “I am not going to go there.”

Vanity Fair: Henry Paulson’s Longest Night

Excerpts from article:

In 2006, Goldman Sachs C.E.O. Henry Paulson reluctantly became Treasury secretary for an unpopular, lame-duck president. History will score his decisions, but the former Dartmouth offensive lineman definitely left everything on the field. In private conversations throughout his term, as crisis followed crisis—Bear Stearns, Fannie Mae and Freddie Mac, Lehman Brothers, A.I.G., and so forth—Paulson gave the author the inside track, from the political lunacy and bailout plans to the sleepless nights and flat-out fear, as he battled the greatest economic disruption in 80 years.

As he noted, “There’s a great lack of financial literacy and understanding in this nation, even among college-educated people.” But Paulson did figure out how to behave on the Hill. “There’s a way, keeping full integrity, of answering the questions you want to answer,” Paulson told me in one of our conversations, reflecting on what he had learned about committee hearings. “The thing that scared me was not a question I didn’t know the answer to. Just say, ‘I don’t know.’ The thing that scared me was some question that I knew, and answered correctly, and I’d be in deep doo-doo!” As his tenure wore on, Paulson confessed, “I amuse myself a lot by sitting there sometimes and thinking what would happen if I said, ‘Do you realize what an idiotic question that is?’ "

Click her to read full article

Bill Gross September 09 Investment Outlook Notes

Here are notes from Bill Gross's Sep 09 Investment Outlook article:

• When it comes to whacking golf ball, the possibilities of explanation are endless: For relaxation, for socialization, to get close to mother nature, etc.
• The "new" vs. "old" normal dichotomy was perhaps best contrasted by Barton Biggs when he said he was a "child of the bull market."
• Biggs' point was for as long as he's been in the market, it has paid to buy the dips because markets, economies, profits and assets always rebounded and went to higher level.
• Economies grow, profits grow, just like children do.
• However, the surprise is that there's been a significant break in that growth pattern because of delevering, deglobalization, and reregulation (DDR).
• DDR in combination means that it's time to recognize that things have changed and that they will continue to change for the next decade or even two.
• We are heading towards the new normal which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which government plays a significant role in terms of deficits and reregulation and control of the economy; in which consumers stops shopping until he drops and begins.
• American-style capitalism and the making of paper instead of things. America would consume, then print paper assets and debt in order to pay for it. Developing countries would make things and accept America's securities in return. This game is over and unless developing countries step up and generate a consumer ethic of their own, the world will grow at a slower pace.
• The invisible hand of free enterprise is being replaced by the visible fist of government. The once-successful "shadow banking system" is being reregulated and delevered.
• Global economic leadership. China has spent three times the amount of money (relative to GDP) to revive its economy and managed to grow at a "near normal" 8% pace vs. U.S. "big R" recessionary numbers.
• Old normal housing models encouraged home ownership, eventually peaking at 69% (sometime in 2004). Subsidized and tax-deductible mortgage interest rates promoted a long-term housing boom and now a significant housing bust.
• Housing alone can't lead U.S. out of this big R recession no matter what the recent Case-Shiller home price numbers may suggest. Home ownership may sink perhaps to a new normal level of 65%, as opposed to 69% of American households.
• The shadow banking system has fueled an American era of consumerism because debt was available, interest rates were low and the living became easy.
• Saving rates plunged from 10% to -1%. Now things have perhaps changed and saving rates are headed up, consumer spending growth rates moving down. A new normal is taking place.
• Increased health care may be GDP positive but it's only a plus from a "broken window" point of view. It's far better to have a younger, healthier society than to spend trillions fixing up an aging, increasingly overweight and diabetic one.
• Same thing goes for energy. Better and more profitable to pump oil than to spend trillions on a new "green" society.
• The investment implications of this new normal evolution cannot easily be modeled econometrically, quantitatively, or statistically. The successful investor during this transition will be one with common sense and importantly the powers of intuition, observation, and the willingness to accept uncertain outcomes.
• PIMCO observes that the highest probabilities favor the following strategic conclusions: 1) Global policy rates will remain low for extended periods of time; 2) The extent and duration of quantitative easing and fiscal stimulation efforts are keys to future investment returns across a multitude of asset categories: 3) Investors should continue to anticipate and shake hands with government policies, utilizing leverage and guarantees to their benefit; 4) Asia and Asian-connected economies (Brazil, Australia) will dominate future global growth; 5) The dollar is vulnerable on a long-term basis.
• Investors need to play conservatively and avoid critical mistakes. An "even par" scorecard may be enough to hoist the trophy in a New Normal world.

WSJ: The Mistakes We Make—and Why We Make Them

By Meir Statman

Published: August 23, 2009

The Mistakes We Make—and Why We Make Them

How investors think often gets in the way of their results. Meir Statman looks into our heads and tells us what we're doing wrong.

What was I thinking?

If there's one question that investors have asked themselves over the past year and a half, it's that one. If only I had acted differently, they say. If only, if only, if only.

Yet here's the problem: While we know that we made investment mistakes, and vow not to repeat them, most people have only the vaguest sense of what those mistakes were, or, more important, why they made them. Why did we think and feel and behave as we did? Why did we act in a way that today, in hindsight, seems so obviously stupid? Only by understanding the answer to these questions can we begin to improve our financial future.

This is where behavioral finance comes in. Most investors are intelligent people, neither irrational nor insane. But behavioral finance tells us we are also normal, with brains that are often full and emotions that are often overflowing. And that means we are normal smart at times, and normal stupid at others.

The trick, therefore, is to learn to increase our ratio of smart behavior to stupid. And since we cannot (thank goodness) turn ourselves into computer-like people, we need to find tools to help us act smart even when our thinking and feelings tempt us to be stupid.

Let me give you one example. Investors tend to think about each stock we purchase in a vacuum, distinct from other stocks in our portfolio. We are happy to realize "paper" gains in each stock quickly, but procrastinate when it comes to realizing losses. Why? Because while regret over a paper loss stings, we can console ourselves in the hope that, in time, the stock will roar back into a gain. By contrast, all hope would be extinguished if we sold the stock and realized our loss. We would feel the searing pain of regret. So we do pretty much anything to avoid that pain—including holding on to the stock long after we should have sold it. Indeed, I've recently encountered an investor who procrastinated in realizing his losses on WorldCom stock until a letter from his broker informed him that the stock was worthless.

Successful professional traders are subject to the same emotions as the rest of us. But they counter it in two ways. First, they know their weakness, placing them on guard against it. Second, they establish "sell disciplines" that force them to realize losses even when they know that the pain of regret is sure to follow.

So in what other ways do our misguided thoughts and feelings get in the way of successful investing—not to mention increasing our stress levels? And what are the lessons we should learn, once we recognize those cognitive and emotional errors? Here are eight of them.

No. 1
Goldman Sachs is faster than you.

There is an old story about two hikers who encounter a tiger. One says: There is no point in running because the tiger is faster than either of us. The other says: It is not about whether the tiger is faster than either of us. It is about whether I'm faster than you. And with that he runs away. The speed of the Goldman Sachses of the world has been boosted most recently by computerized high-frequency trading. Can you really outrun them?

It is normal for us, the individual investors, to frame the market race as a race against the market. We hope to win by buying and selling investments at the right time. That doesn't seem so hard. But we are much too slow in our race with the Goldman Sachses.

So what does this mean in practical terms? The most obvious lesson is that individual investors should never enter a race against faster runners by trading frequently on every little bit of news (or rumors).

Instead, simply buy and hold a diversified portfolio. Banal? Yes. Obvious? Yes. Typically followed? Sadly, no. Too often cognitive errors and emotions get in our way.

No. 2
The future is not the past, and hindsight is not foresight.

Wasn't it obvious in 2007 that financial institutions and financial markets were about to collapse? Well, it was not obvious to me, and it was probably not obvious to you, either. Hindsight error leads us to think that we could have seen in foresight what we see only in hindsight. And it makes us overconfident in our certainty about what's going to happen.

Want to check the quality of your foresight? Write down in permanent ink your forecast of tomorrow's stock prices. Do that each day for a year and check the accuracy of your predictions. You are likely to find that your foresight is not nearly as good as your hindsight.

Some prognosticators say that we are now in a new bull market and others say that this is only a bull bounce in a bear market. We will know in hindsight which prognostication was right, but we don't know it in foresight.

When I hear in my mind's ear a voice that says that the stock market is sure to zoom or plunge, I activate my "noise-canceling" device rather than go online and trade. You might wish to install this device in your mind as well.

No. 3
Take the pain of regret today and feel the joy of pride tomorrow.

Emotions are useful, even when they sting. The pain of regret over stupid comments teaches presidents and the rest of us to calibrate our words more carefully. But sometimes emotions mislead us into stupid behavior. We feel the pain of regret when we find, in hindsight, that our portfolios would have been overflowing if only we had sold all the stocks in 2007. The pain of regret is especially searing when we bear responsibility for the decision not to sell our stocks in 2007. We are tempted to alleviate our pain by shifting responsibility to our financial advisers. "I am not stupid," we say. "My financial adviser is stupid." Financial advisers are sorely tempted to reciprocate, as the adviser in the cartoon who says: "If we're being honest, it was your decision to follow my recommendation that cost you money."

In truth, responsibility belongs to bad luck. Follow your mother's good advice, "Don't cry over spilled milk."

Where am I leading you? Stop focusing on blame and regret and yesterday and start thinking about today and tomorrow. Don't let regret lead you to hold on to stocks you should be selling. Instead, consider getting rid of your 2007 losing stocks and using the money immediately to buy similar stocks. You'll feel the pain of regret today. But you'll feel the joy of pride next April when the realized losses turn into tax deductions.

No. 4 Investment success stories are as misleading as lottery success stories.

Have you ever seen a lottery commercial showing a man muttering "lost again" as he tears his ticket in disgust? Of course not. What you see instead are smiling winners holding giant checks.

Lottery promoters tilt the scales by making the handful of winners available to our memory while obscuring the many millions of losers. Then, once we have settled on a belief, such as "I'm going to win the lottery," we tend to look for evidence that confirms our belief rather than evidence that might refute it. So we figure our favorite lottery number is due for a win because it has not won in years. Or we try to divine—through dreams, horoscopes, fortune cookies—the next winning numbers. But we neglect to note evidence that hardly anybody ever wins the lottery, and that lottery numbers can go for decades without winning. This is the work of the "confirmation" error.

What is true for lottery tickets is true for investments as well. Investment companies tilt the scales by touting how well they have done over a pre-selected period. Then, confirmation error misleads us into focusing on investments that have done well in 2008.

Lottery players who overcome the confirmation error conclude that winning lottery numbers are random. Investors who overcome the confirmation error conclude that winning investments are almost as random. Don't chase last year's investment winners. Your ability to predict next year's investment winner is no better than your ability to predict next week's lottery winner. A diversified portfolio of many investments might make you a loser during a year or even a decade, but a concentrated portfolio of few investments might ruin you forever.

No. 5 Neither fear nor exuberance are good investment guides.

A Gallup Poll asked: "Do you think that now is a good time to invest in the financial markets?" February 2000 was a time of exuberance, and 78% of investors agreed that "now is a good time to invest." It turned out to be a bad time to invest. March 2003 was a time of fear, and only 41% agreed that "now is a good time to invest." It turned out to be a good time to invest. I would guess that few investors thought that March 2009, another time of great fear, was a good time to invest. So far, so wrong. It is good to learn the lesson of fear and exuberance, and use reason to resist their pull.

No. 6 Wealth makes us happy, but wealth increases make us even happier.

John found out today that his wealth fell from $5 million to $3 million. Jane found out that her wealth increased from $1 million to $2 million. John has more wealth than Jane, but Jane is likely to be happier. This simple insight underlies Prospect Theory, developed by Daniel Kahneman and Amos Tversky. Happiness from wealth comes from gains of wealth more than it comes from levels of wealth. While gains of wealth bring happiness, losses of wealth bring misery. This is misery we feel today, whether our wealth declined from $5 million to $3 million or from $50,000 to $30,000.

We'll have to wait a while before we recoup our recent investment losses, but we can recoup our loss of happiness much faster, simply by framing things differently. John thinks he's a loser now that he has only $3 million of his original $5 million. But John is likely a winner if he compares his $3 million to the mountain of debt he had when he left college. And he is a winner if he compares himself to his poor neighbor, the one with only $2 million.

In other words, it's all relative, and it doesn't hurt to keep that in mind, for the sake of your mental well-being. Standing next to people who have lost more than you and counting your blessings would not add a penny to your portfolio, but it would remind you that you are not a loser.

No. 7 I’ve only lost my children’s inheritance.

Another lesson here in happiness. Mental accounting—the adding and subtracting you do in your head about your gains and losses—is a cognitive operation that regularly misleads us. But you can also use your mental accounting in a way that steers you right.

Say your portfolio is down 30% from its 2007 high, even after the recent stock-market bounce. You feel like a loser. But money is worth nothing when it is not attached to a goal, whether buying a new TV, funding retirement, or leaving an inheritance to your children or favorite charity.

A stock-market crash is akin to an automobile crash. We check ourselves. Is anyone bleeding? Can we drive the car to a garage, or do we need a tow truck? We must check ourselves after a market crash as well. Suppose that you divide your portfolio into mental accounts: one for your retirement income, one for college education of your grandchildren, and one for bequests to your children. Now you can see that the terrible market has wrecked your bequest mental account and dented your education mental account, but left your retirement mental account without a scratch. You still have all the money you need for food and shelter, and you even have the money for a trip around the country in a new RV. You might want to affix to it a new version of the old bumper sticker: "I've only lost my children's inheritance."

So here's my advice: Ask yourself whether the market damaged your retirement prospects or only deflated your ego. If the market has damaged your retirement prospects, then you'll have to save more, spend less or retire later. But don't worry about your ego. In time it will inflate to its former size.

No. 8 Dollar-cost averaging is not rational, but it is pretty smart.

Suppose that you were wise or lucky enough to sell all your stocks at the top of the market in October 2007. Now what? Today it seems so clear that you should not have missed the opportunity to get back into the market in mid-March, but you missed that opportunity. Hindsight messes with your mind and regret adds its sting. Perhaps you should get back in. But what if the market falls below its March lows as soon as you get back in? Won't the sting of regret be even more painful?

Dollar-cost averaging is a good way to reduce regret—and make your head clearer for smart investing. Say you have $100,000 that you want to put back into stocks. Divide it into 10 pieces of $10,000 each and invest each on the first Monday of each of the next 10 months. You'll minimize regret. If the stock market declined as soon as you have invested the first $10,000 you'll take comfort in the $90,000 you have not invested yet. If the market increases you'll take comfort in the $10,000 you have invested. Moreover, the strict "first Monday" rule removes responsibility, mitigating further the pain of regret. You did not make the decision to invest $10,000 in the sixth month, just before the big crash. You only followed a rule. The money is lost, but your mind is almost intact.

Things could be a lot worse.

--Mr. Statman is a professor of finance at Santa Clara University in Santa Clara, Calif.

World Safest Banks

As published by Global Finance Magazine, the world's safest banks for midyear 2009 are as follows:

THE MID YEAR SAFEST BANKS RANKINGS

RANKING	BANK	COUNTRY
1	KfW	Germany
2	Caisse des Dépots et Consignations (CDC)	France
3	Bank Nederlands Gemeenten (BNG)	Netherlands
4	Landwirtschaftliche Rentenbank	Germany
5	Rabobank	Netherlands
6	Landeskreditbank Baden-Wuerttemberg-Foerderbank	Germany
7	NRW. Bank	Germany
8	BNP Paribas	France
9	Banco Santander	Spain
10	Royal Bank of Canada	Canada
11	National Australia Bank	Australia
12	Commonwealth Bank of Australia	Australia
13	Banco Bilbao Vizcaya Argentaria (BBVA)	Spain
14	Toronto-Dominion Bank	Canada
15	Australia & New Zealand Banking Group	Australia
16	Westpac Banking Corporation	Australia
17	Banco Espanol de Credito S.A. (Banesto)	Spain
18	ASB Bank	New Zealand
19	HSBC Holdings	United Kingdom
20	Crédit Agricole	France
21	Wells Fargo	United States
22	Nordea Bank	Sweden
23	Scotiabank	Canada
24	La Caixa	Spain
25	Svenska Handelsbanken	Sweden
26	U.S. Bankcorp	United States
27	DBS Bank	Singapore
28	Pohjola Bank	Finland
29	Deutsche Bank	Germany
30	Société Générale	France
31	Intesa Sanpaolo	Italy
32	Bank of Montreal	Canada
33	DnB NOR Bank	Norway
34	The Bank of New York Mellon	United States
35	Banco Popular Español	Spain
36	Caixa Geral de Depositos	Portugal
37 =	United Overseas Bank	Singapore
37 =	OCBC (Oversea-Chinese Banking Corp.)	Singapore
39	Axa Bank Europe	Belgium
40	Landesbank Baden-Wuerttemberg	Germany
41	Nationwide Building Society	United Kingdom
42	CIBC	Canada
43	National Bank of Kuwait	Kuwait
44	UBS	Switzerland
45	JPMorgan Chase	United States
46	Bank of Tokyo-Mitsubishi UFJ	Japan
47	Credit Suisse Group	Switzerland
48	Banque Fédérative du Crédit Mutuel (BFCM)	France
49	Crédit Industriel et Commercial (CIC)	France
50	BB&T Corporation	United States

Common Tricks Used To Disguise Earnings

Here are some common tricks use to distort or disguise real earnings performance and how the truth is buried in the financial statements.

The Pro-Forma Pretense:

When two companies merge, a "pro-forma" or "as if" financial statements are issued. The aim is to give investors with an idea of what the merged entity's financial numbers will look like - as if it had been operating as one. In the 1990s, pro-forma statements became a favorite tool of companies to obscure shaky finances. It is especially a popular for the high-tech companies as they discovered that using pro-forma earnings announcements could allow them to selectively exclude many types of expenses that reduce earnings to cover up the fact that they had little or no earnings as defined by GAAP. Other companies in many other industries soon followed suit.

Because pro-forma earnings by its very nature are not GAAP-compliant, few rules dictated what went in, or what stayed out, of a pro-forma statement. But with the passage of Sarbanes-Oxley corporate reform law, the law dictates that all pro-forma earnings must be reconciled to the most directly comparable GAAP financial measure. Some companies excluded restructuring costs under the excuse that they were "unusual" or not part of the company's core operations. Other left out depreciation and amortization expenses, and yet others excluded interest and tax payments. So when a company announces pro-forma earnings, make sure you keep reading until you get to the GAAP number, which you can then see if there're indeed any ugly details that pro-forma excludes.

If used properly, pro-forma numbers can make sense as to which really are unusual and which ain't. But some companies went to ridiculous extent. Take the case of SEC case brought against Trump Hotels & Casino Resorts in January 2002. This case highlights how far companies had bent the rules to get investors to focus on pro-forma results. In October 1999, the company issued a press release announcing the third-quarter pro-forma net income of $14 million, and touted that its positive operating result had beaten analysts' expectations. The release also made clear that the pro-forma results excluded a one-time charge of $81.4 million from closing down a hotel and casino in Atlantic City. But the release did not state that the pro-forma earnings included a $17.2 million, one-time gain, which was the result of some termination of lease. The company had simply chosen to include its pro-forma calculation a one-time event that made its earnings rosier, while selectively excluded a much larger charge that would have made earnings look anemic. Next time you see a pro-forma earnings, be sure you know the assumptions behind the numbers. Read the entire press release and don't jump to conclusions based on a headline. Companies usually want you to focus on the headline and ignore the details so that you won't get to the ugly truth.

The Big Bath:

When companies restructure by selling unprofitable units, laying off workers, or closing production facilities, they often take a one-time charge that bundles the costs of the restructuring. Inherently, there's nothing wrong as long as the management views restructuring charges as a last resort to boost efficiency and restore profitability by writing off only those expenses that directly relate to the restructuring. But some companies use restructuring exercises like a cemetery - to bury all kinds of everyday operating expenses - to clean up its balance sheet. By taking "one big bath" in a single year, companies can pretty up an otherwise desultory earnings into better earnings in the future years. Why would companies want to take restructuring charges that overstate costs even though that makes losses look worse? Because managers and analysts have convinced investors and Wall Street to that one-time loss doesn't matter and look to future earnings. Once Wall Street is convinced, the analysts will tell you that a restructuring charge is all about the past and that it matters little, or nothing, to the company's future prospect. For companies, the beauty of restructuring is that they can front-load several years of expected future expenses into one big package which allows the company to boost future earnings by not offsetting income-producing activities with their associated expenses. Investors who ignore big bath accounting is ignoring at their own perils. Investors should dig out the underlying reasons for the write-off, which may be a signal to sell.

Cookie Jars and Channel Stuffing:

Warren Buffett warns us companies that cannot make the numbers may eventually chose to make up the numbers. Companies can deceive investors with a number of accounting shenanigans. Two of the more common tricks are called "cookie-jar reserves" and "channel stuffing."

• Cookie-jar reserving or accounting occurs when a company intentionally overestimates future liabilities for items such as loan losses (for banks), warranty costs, loss and loss adjustment expenses (for insurance), or sales returns. By doing so, a company can stash money in cookie jars during good times and reach for them when needed in bad times.

• Channel stuffing is the business practice where a company inflates its sales figures by stuffing or forcing more products through a distribution channel and thus loading the channel with more than it is capable of selling. To entice customers to load up with more than they really need, the company often offers discounts, below-market financing, extension of payment terms, or easing of return policy. While such hurry-up sales rob revenue from future quarters, they help cover up a bad quarter so that management can boast that it met analysts' estimates.

Channel stuffing are not without its consequences, by easing the selling policy of the company, the potential for higher default in payments, or return of sales, increases. Besides, it is illegal. In May 2001, Sunbeam Corp. (now part of Jarden Corp.) is alleged by the SEC that the company used both methods in a fraudulent attempt to trick the market into believing that the company was worth more than it really was. According to the allegation, Albert Dunlap, the former CEO and Chairman, was hired by Sunbeam's board in 1996 to restructure the ailing company. As a so-called turnaround specialist, Dunlap set to reorganize the company and promise shareholders quick results. After taking a restructuring charge and reporting huge losses for 1996 - which Dunlap was able to blame on the previous management - the company then reported a record profit of $189 million from continuing operations. But the SEC alleged that the feat was achieved in part by reaching into the cookie jar that was reserved in 1996. In addition, the company is alleged that the record profit was achieved at the expense of future results by inducing customers to buy merchandise they didn't need. Sunbeam had used a scam called "bill and hold," in which it recorded the sale of merchandise but held them in its own warehouses because the customers didn't yet need, or didn't want, the goods. Under GAAP, a bona fide sale takes place only when the customer takes possession of the goods or requests that they be stored. Of that $189 million, the SEC alleged that at least $60 million came from accounting fraud. Because Sunbeam robbed from future results in 1997, it became increasingly desperate to make its numbers in 1998, and was forced to repeat its sins. This time not only did Sunbeam engaged in channel stuffing, but it also deleted certain records to conceal pending returns of merchandise. Now only the sales, and not the returns, appeared on the books. Such case is not unique to Sunbeam, larger companies like Bristol Myers Squibb also engaged in such alleged frauds, though not to the extent of destroying records. In the end, both cases were settled with the SEC without admitting or denying the allegations - which seems a commonality.

There are other ways companies can cook their revenue books by recognizing revenue before the service or product is delivered. For example, a company may sell computers along with a five-year servicing contract along. Under GAAP rules, the service contract must be spread evenly over 5 years as the company "earns" it, or 20% of the service contract value each year. The computer sales however must be recognized immediately once it is delivered. But when the computer and the service contract are sold together for a single "package" price, separating the components can be subject to manipulation. Booking revenues prematurely results in inflated sales figures and misrepresents earnings result - in fact it is similar to "robbing Peter to pay Paul" when companies rob revenues from future periods and recognize it in the current period.

Write-downs and Reversals:

When a company stockpiles on goods it can't sell, and the value of the goods declines below what it will be sold for, accounting rules require that the company writes down the value of the inventory on the balance sheet. In a well-run company, write-downs should be minimal because managers pay proper attention to the supply chain signals of customers and inventory levels and the timing of new product introductions.

In 2001, the telecom and internet-gear companies wrote down massive amounts of equipment because they missed warning signs that their sales forecasts were overly optimistic. Cisco Systems shocked investors when it took one of the biggest such write-downs in April 2001. The company took a over $2 billion of write-down. Instead of liquidating the unnecessary inventory, Cisco kept it in warehouses and denied it ever intended to use or sell the goods in a future quarter. In a press release, instead of proclaiming a loss of $2.7 billion under GAAP, Cisco touted its pro forma earnings of $230 million by burying the $2.2 billion in excess inventory charge. Not only did the managers miscalculated the supply and demand - the crux of their job - they also treated the error as a book keeping exercise by downplaying the loss of real shareholders' wealth because real money were spent.

And by keeping the written-down inventories, the company would be able to report far better results by comparison to its outsized loss in 2001. If a company ends up using or selling the inventory it has written down, the offsetting expenses associated with those sales will be vastly lower, and thus profits can appear healthier than it really is. Eight months after Cisco's write-down, the company did just that and revealed in its 1Q02 earnings report: it had sold or used in production or research $290 million in "excess inventory" that it had previously termed worthless. The upshot was that the net loss of $268 million in the first quarter of 2002 would be much worse without this benefit.

Vendor Financing:

Companies sometimes lend their customers the funds to make purchases in order to boost sales. By doing so, the company is basically buying its own products. Motorola gives a good case that vendor financing can backfire. In February 2000, the company announced that it had sold $1.5 billion of equipment to Turkey's wireless carrier, Telsim. But investors had to wait more than a year to read in Motorola's proxy statement of March 30, 2001, that the company had lent $2.8 billion to customers to finance their purchase of Motorola wireless gear. Of that, $1.7 billion had gone to Telsim alone - a big exposure for such a significant amount lent to a single customer. A little over a month later, Motorola revealed that Telsim's debt was even deeper at $2 billion, out of a total of $2.9 billion in so-called finance receivables, or customer loans. It is also revealed that out of the $2 billion, $728 million was past due. However, the proxy left the strong impression that it had adequate collateral if Telsim failed to repay in 30 days - Telsim had pledged 66% of its stock to Motorola in case of default. In the next quarterly report in July 2001, shareholders got a shock when the entire $2 billion is in default. When Motorola notified Telsim that it was in default, Telsim issued more shares in the Turkish stock market and diluted the Telsim shares that Motorola held as collateral from 66% to 22%. That left Motorola with little recourse but to write off the loan. The following quarter, Motorola took a $1.3 billion charge against earnings.

The lesson is investor must be vigilant. Had an investor been so, they would have spotted clues in Motorola's financial statements. The first hint of any exposure was buried on page 53 (of 104) in Motorola's March 2001 proxy statement. It referred to "one customer in Turkey" responsible for $1.7 billion out of $2.8 billion in long-term finance receivables. In the next three quarters, the company slowly dribbled out information about the Telsim loans, ultimately hitting investors with a two-by-four when it announced the $1.3 billion charge.

Goodwill Games:

Until 2001, accounting rules allowed companies to account for business acquisitions in two ways: Pooling of interests or purchase accounting. When companies evaluate the value of an acquisition, they forecast the cash it expects the acquired company to generate. It also places a price on each of the assets such as equipment, plant and inventory. Assets can also be intangible, i.e., they have no physical form, such as intellectual properties like patents, brand names, quality of personnel and market share. When one company acquires another and pays a premium in excess of the value of its identifiable assets, the premium is called goodwill.

In the past, the far more popular accounting selected to account for acquisition is pooling of interest, in which companies simply combined their assets and liabilities by declaring their combination as a mere uniting of shareholder interest, as if no resources were used up and no goodwill was involved. The other method, purchase accounting is far less popular. Using the purchase method, companies could allocate the amount paid to all the assets acquired, including goodwill: the amount in excess of the identifiable assets is allocated and recognized as goodwill which must be amortized as an expense each year over a period of not more than 40 years. So you can see why companies elected the pooling method over the purchase method because the purchase method reduces reported earnings (though not economic earnings).

However, in 2001, the FASB changed all that when it ended the use of the pooling method. All acquisitions must be accounted under purchase accounting. But, at the same time, it lifted the requirement for companies to amortize goodwill. This means goodwill will no longer have to be expensed and thus no reduction of earnings tied to amortization of goodwill for years to come. Instead, companies must determine on an annual basis if the value of goodwill is impaired, or lost value, since the acquisition took place.

The merger of AOL and Time Warner, at the height of the internet frenzy, is an instructive case. It quickly showed how goodwill accounting changes can affect shareholders' interests, and expose the misjudgment of managers. Upon the combination of the two companies in 2001, it carried $127 billion in goodwill on the balance sheet. The large amount reflected both the inflated stock prices of the era and the excessive prices companies paid for acquisitions. Under the new FASB rule, the company announced that its goodwill is no longer worth $127 billion. As a result, it took the largest write down in history of $54 billion charge, in the 2002 first quarter earnings report. The company downplay the write-down as merely a paper correction, cheered on by most analysts, because it involves no hard cash, and have no effect on future earnings.

But is such huge write-offs really meaningless or pen-pushing events? This shows both companies hugely overvalued themselves and caused shareholders to overpay when the two companies merged. The truth is, goodwill write-offs and not amortizing goodwill allow companies to artificially lift their return of assets and return on equity, two key measures of a company's profitability. For example, AOL, expects to generate as much as $6.8 billion in additional profit in 2002 because it won't have to amortize any of the goodwill it carries on its balance sheet. By not deducting goodwill from earnings, it simply boost future earnings, until one fine day, the company finds it advantageous for them to take one big bath of impairment charges and wave it off as an insignificant event that does not affect cash flow.

Now, you can see, how far companies can bend backwards to use all kinds of accounting tricks to make earnings glossier than it really is. Most companies are not committing frauds even if they resort to smoke and mirrors accounting. Some of the more aggressive accounting path taken may even be legal because GAAP, even at its best, has plenty of built-in flexibility that allows companies to take liberties. And this is the real travesty. Nothing will change corporate managers from doing what they do.

No doubt any company that overplay the numbers game will have to restate earnings and losses will follow for not only the company, but shareholders as well. But for shareholders, it may be too little too late. So to avoid it, we, as investors must change our behaviors: 1) Never follow the herd and grab shares just because the headline suggests so and never sell just because the company falls short of analysts' expectations; 2) Read the footnotes and if you don't, the managers will be happy; 3) It's your responsibility to dig deeper to see what the true economic prospect the company has.

NYT: Warren Buffett's 'Greenback Effect' Warning: A Call to Buy Stocks

The Greenback Effect

Warren Buffett is back with a new piece in the New York Times, but today he's not using the high-profile platform to explicitly urge us all to buy stocks as he did last October. But there's still a big "buy" recommendation implicit in the dollar doomsday scenario he lays out in his latest op-ed. Click here for full article.