Opinion: Spotting dodgy practice is key to good investment
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I can still recall an intense and angry argument with a supercilious bank manager who, I belatedly discovered, was guilty of a sleight of hand which had a damaging impact upon my business and staff. I won’t bore you with the details, but as a result of his actions, any trust I had in the guy and his bank went out of the window.
Recognising and dealing with sleight of hand, over-inflated claims or various forms of dodgy practice is a skill you must master should you wish to run your own business. After all, you’re likely to be selling your product or service into an established market populated by folks boasting a lot more experience than you.
The skill is one investors should also acquire at the earliest opportunity, because in keeping with those unwritten rules governing markets of any description, those in which shares are traded can be dangerous places.
Investing in stock markets can be a rewarding exercise. I made my first foray into equities more than a quarter century ago and almost inevitably, in between modest successes have made a number of mistakes. Actually, in several instances, it would be more accurate to substitute the word ‘howlers’ for ‘mistakes’. With the benefit of hindsight, I realise I’ve taken ridiculous levels of risk, or believed a stock’s share price would continue to rise when every single indication screamed otherwise.
Fortunately, I have not (yet) encountered an outright fraud which resulted in significant losses, although the supercilious bank manager’s actions came close.
The stock market has an uncanny habit of regularly revealing frauds, accounting scandals or plain theft, sometimes on a massive scale, although such behaviour is not limited to listed companies.
For example, older readers will recall the Serious Fraud Office (SFO) raiding the premises of stock market darling Polly Peck in 1990 before the firm collapsed and 70 charges of false accounting and theft were brought against chief executive Asil Nadir. It would be more than two decades, however, before Nadir was found guilty and imprisoned for ten years.
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Then there was the BCCI scandal. The bank claimed to have assets worth $20 billion, but that boast disguised a massive money laundering operation.
Over in the United States, the expert manipulation of accounting loopholes worked for a while as Enron’s share price powered beyond $90 in mid-2000. The following year, the shares were valued at less than $1; Enron collapsed and several senior executives headed to gaol.
Remember WorldCom? This was another US-based outfit which distributed impressively chunky dividends to shareholders until it was discovered that the company had deliberately inflated profits by $4 billion. How do seemingly intelligent people, including the company’s board of directors, for example, miss something as blatant as that?
More recently, the demise of outfits such as Carillion and Patisserie Valerie hit shareholders hard.
In 2018, Pat Val’s (clearly alert) board of directors discovered overdrafts totalling £10 million in two ‘hidden’ bank accounts, prompting the arrest of the firm’s finance director and an eye-watering loss of £183 million for founder Luke Johnson after the company went into liquidation.
Carillion is one of the companies featured in Tim Steer’s excellent book, The Signs Were There, which shows investors how to spot financial warning signs in company accounts.
“Even a cursory look at the balance sheet by anyone with a smattering of financial training would have evoked…the realisation that [Carillion] was heading for a fall,” notes Mr Steer, a retired fund manager, who uses the Carillion example to introduce his ‘Iceberg Principle’.
“An annual report should be seen as an iceberg in terms of the information it contains,” he writes. “It cannot tell you all you need to know about a company, but if there is something in it that makes you feel uneasy, there may well be other even more uncomfortable things lying below the metaphorical water line. And that is often reason enough to sell the shares if you have a holding in the company, or to avoid it if you have not.” Solid advice.
Annual reports published by many listed companies have become glossy affairs, increasingly loaded with woke-isms, copy-and-paste platitudes and banal statements with the financial details tucked away towards the rear.
Mr Steer’s premise is that it’s worth taking the time to read and examine the ‘boring financial stuff’ if you want to avoid being on the receiving end of a sleight of hand, making his book a valuable addition to any investors’ bookshelves.
THE WEEK IN NUMBERS
- £400 - Staff at Cranswick, the port seller, are due to collect a £400 bonus on top of the £500 bump they received last year after the company reported a 14% hike in annual revenue. The cause? A lockdown-related surge in Britons’ penchant for the full English breakfast and roast dinners.
- Minus £1.4 billion - Unlike Cranswick, Landsec, one of the country’s largest commercial landlords, reported a whopping £1.4bn loss earlier this week. Nevertheless, in an upbeat announcement, Landsec said it was seeking to buy more shopping centres as retailers’ demand for space continued to soar.
- 7,700 - Online car dealer Cazoo sold 9,762 vehicles in the first three months of 2021, an increase of 7,700 on the same period last year. The company saw first quarter sales increase from £19.6 million in 2020 to £113.9 million this year.