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The
Wall Street Journal: Investors Be Wary of Big Write Offs
NYSSCPA.org E-zine Staff
NEW YORK - Wall Street stock analysts usually tell investors to ignore large write offs because they provide little insight about future performance. Now, amid the biggest wave of write offs in history, mounting bankruptcies, and the collapse of Enron, it may be time to revisit that wisdom, The Wall Street Journal reported .
Almost any kind of write-off can send a message about the soundness of a business, the competence of its management or its prospects for growth. Although Wall Street stock analysts and financial executives routinely tell investors to disregard these entries, others say they're among the things investors should most closely heed.
"When you see these large write downs, the antenna should go up immediately, and you should start digging for the underlying business reasons for these losses," said Lynn Turner, an accounting professor at Colorado State University and a former chief accountant for the Securities and Exchange Commission.
A study by Multex.com and The Wall Street Journal found that companies taking the largest unusual charges as a percentage of sales have substantially poorer stock returns in the three months following the announcement of the charge than companies with minimal or no such charges.
The study, covering the past six years, looked at stocks of all public companies with market capitalizations of $1 billion or more. It divided those that took unusual charges into 10 groups, from the smallest to the largest such charges as a percentage of revenue. Stocks of companies with the largest charges relative to sales had a median decline of 9.4 percent in the 90 days after the charge was taken. Stocks of companies with the smallest charges relative to sales had a median gain of 1.48 percent.
Marc Gerstein, director of investment research at Multex.com, said the study shows that "if you want to weed out stocks to look at for investment purposes, companies with unusually large write-offs are a good place to start."
Sometimes the significance of special charges isn't immediately clear. But some investors grow suspicious anyway on the "cockroach theory": Where there's one problem, there probably are more.
"From seemingly minor or immaterial charges, sometimes investors can glean insight into how a company either correctly or incorrectly accounts for its business and whether a company is pushing the envelope," said James Chanos, president of Kynikos Associates, a firm that specializes in short-selling, or betting on stock declines.
Many short-sellers raised their bearish bets on Enron Corp. in mid-October after it took a $1.01 billion charge largely to write down the value of soured investments. Inside the charge was a $35 million write-off of investment losses at a partnership controlled by the company's chief financial officer. Later revelations about that and other partnerships, which weren't consolidated into the Houston-based energy concern's financial statements, led the market to lose faith in the company's finances. Its stock now trades for under a dollar a share as the company seeks to restructure under bankruptcy law.
The significance of special charges -- whether they represent old baggage from the past or illuminate the future -- is at the center of a lively debate under way in the accounting world. One side holds that generally accepted accounting principles, or GAAP, provide the best available snapshot of a company's financial position. GAAP, which companies must use in their official financial statements, requires that nearly all charges be treated as ordinary expenses.
Others, including many stock analysts, contend the best view comes from "pro forma" financial results -- calculated "as if" many expenses didn't really exist. The idea is that these expenses aren't relevant to future performance.
Companies increasingly highlight the pro forma view in news releases they generally put out before their official filings with regulators. But pro forma calculations adhere to no particular standard. Companies essentially do what they want. Now, accountants and economists say the practice of excluding blemishes is so widespread that companies and analysts often guide investors to dismiss charges that contain prescient warnings.
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