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Like the George Bush Refund Checks All Over Again...
Remember back in 2001 when George Bush sent out stimulus checks to taxpayers all over America?
People got anywhere from $300 to $600 in the mail.
Well, a similar thing is happening this year.
On December 18, 2015, President Obama quietly signed a bill that gives 119 million eligible Americans the chance to collect on "consumer rebate checks" that could go anywhere from $1,230 to $12,900 for some people.
There are no income requirements to collect. The rich and poor alike are eligible. But you do have to claim your share by April 18 to get your payout. Details here.
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Act Like a Short Seller... to Protect Your Portfolio
My advice for you today is simple: Think like a short seller.
I'm sure you're wondering... What do you mean? And why?
Here's what I mean and why:
When it comes to fraud, it's easy to blame the chumps on Wall Street. The research analysts, investment bankers and, worst of all, brokers are - more often than not - the mortal enemy of the individual investor.
Nevertheless, Wall Street isn't the only one endangering your returns. The management teams of the very stocks you own could very well be cooking the books.
A recent survey of 375 CFOs found that they believe 20% of companies intentionally distort their earnings during any given time period. That is a whopping one in five. Additionally, these distortions are done within the generally accepted accounting principles (often abbreviated "GAAP").
Even more disturbing was the magnitude of their findings. CFOs believe those companies misrepresent their earnings, on average, by 10%.
Now, most of these misrepresentations are not an indication of outright fraud. But some of them are. So how can you find out if one of the companies in your portfolio is playing games with its financials before the potential fallout?
Think like a short seller.
Go With the Flow
Don't get me wrong - uncovering accounting fraud isn't easy and requires pretty extensive forensic accounting skills. The best short sellers have them; most investors do not. However, almost anyone can spot the warning signs early on... if they know where to look first: free cash flow.
As Marc has mentioned, earnings can be (and regularly are) manipulated. GAAP gives management teams the discretion to push back or pull in expenses and revenue to "make the number" expected by Wall Street analysts.
In short, earnings don't tell the whole story.
Free cash flow is much more difficult to finagle. It is the money that the company's business actually brings in each month after accounting for capital expenditures.
Earnings should be backed by free cash flow. If they are not, especially over the long term, it is a huge red flag that there is something fishy going on.
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Remember, when a company discloses accounting problems, management's integrity is questioned. The stock always falls. It doesn't matter how large or small the disclosure is.
In my experience, if there are questions about a company's accounting policies, it is best to get out now and ask questions later. When it comes to your portfolio, if a company's numbers don't add up, it's time to move on. Funny math is a battle few investors on the long side ever win.
Good investing,
Kristin
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