Unmasking Methods Used by Businesses to Conceal Poor Performance
By Anthony Rhodes
When managed correctly, a business should operate like a well-oiled machine. Incomes should exceed outflows, supply chains should be consistently scrutinized and improved upon, and boardrooms should exert appropriately applied pressure towards management, ensuring that all systems of performance are routinely optimized for long-term, sustainable growth.
When these functions aren't properly aligned, some proverbial gunk may begin to seep into the lubrication, causing systemic stress, and impeding the machinery from performing at peak efficiency. Accompanied by the demands of meeting Wall Street earnings expectations, such strains can result in some resorting to clever accounting tricks and other maneuvers to conceal their dysfunction, with none but the ardently studious among us being the wiser.
These deceptions can provide a short-term reprieve for those implementing such tactics, but eventually, the machinery will begin to stall. When it does, those investors unfortunate enough to own their shares will have to face a financial reckoning with profound monetary consequences. And the resulting fallout can take years to recover from.
The Feeding Facade
When you notice a company going on an acquisition spree, your investing insticts should immediately alert you that something underneath is possibly going awry. Purchasing other companies is one of the methods used by corporations to conceal growth deficiencies, as the performance of the acquired entity becomes accretive to its earnings, ideally concealing any shortcomings which the acquiring company may, in truth, possess. This house of cards can take years to construct, and its immediate success can forestall, or even contribute to the acquiring companies' reluctance towards making the necessary changes to place it back on the path of long-term sustainability. But like all false facades, illusion will eventually give way to reality, with the reputation of the company involved suffering catastrophic damage once the fraudulent scandal is finally uncovered.
Numbers don't lie, but they can certainly be manipulated in a way to conceal the truth. Cottage industries actually exist which can hide growth deficiencies by expertly burying them within a cacophany of numeric formulas. And only well-trained accountants will discover them, but often after a considerable amount of time has subsequently passed. This tactic is based on the assumption that "it's easier to receive forgiveness than approval" and provides the company involved with the primary resource which the scheme absolutely needs in order to succeed: time. Once the 'accounting irregularities' have been unmasked (often as a result of an internal investigation by the perpetrating company), the parties involved have usually generated enough time to ride out the worst of its dysfunctional growth issues. What generally follows is an announcement stating that it is 'changing its accounting practices', the payment of a few punitive fines, and perhaps some sacrificial lambs offered up to the regulatory gods, for all of their time and troubles.
Successful investing involves not only the purchasing of stocks, but also includes deciphering the inner workings of them. Understanding corporate psychology can provide valuable insights into the fears and motivations of companies, and from that point, it's not difficult to assess the actions which some will take to either avoid or reward those sensations.
Depending on how well each company is managed is the primary determinate as to whether these actions will produce positive or negative consequences. So focusing your attention on the corporation, and not just the stock, should place you on the best path of discovering which one it is most likely to be.
(Anthony Rhodes is the President and owner of wealth management firm The Planning Perspective www.theplanningperspective.com. Do not reproduce without permission.)