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Much of Enron's undoing came from what has been described as 'off-balance sheet transactions and events.' The average investor doesn't even look at a company's balance sheet, let alone dig into footnotes. Furthermore, Enron's balance sheet didn't look so bad, right up until the moment that the company had to 'restate' everything. So investors who took the time to do their homework still might not have seen the red flags until it was too late.
What gives? There's no other answer - we're clinically depressed. "We're clearly in the middle of a contagious social and economic epidemic that is distorting emotions," said Richard Geist, head of The Institute of Psychology and Investing and a Harvard professor. "The symptoms are easy to diagnose: A belief that all companies are dishonest, an urge to engage in panic selling and a real inability to de-center ourselves from the doom-and-gloom of media reports." This is no New Age psychobabble. The market is in the downside of a manic-depressive episode that's seriously dampened the public mood. "Investors and portfolios managers appear to be clicking (on trades) first and asking questions later. While it's true the tragic consequences of Enron for employee pension plans can't be overestimated, the reckless abandon with which the accounting irregularities have driven stocks back to November lows is a fascinating study in how investors are unable to control their emotions," Geist said. The state of mind of investors still grieving losses is in marked contrast to that of consumers, who've single-handedly warded off the steep downturn that legions of economists predicted. Of course, many consumers and investors are one-in-the-same, and they're suffering schizoid attacks as a result of their clashing positive and negative outlooks. Consumers are pleased to get that car at zero-interest financing, but then they're somewhat disappointed in the car makers' profit and sell their stock. We've yet to fully recognize the improving conditions because we're stymied by insecurity over what's to come, said Robert Siroka, a human-relations expert at the Socio-Metric Institute in New York. "During the euphoria stage, whatever came next was going to be better," Siroka said. "Now, what's coming next is only going to be worse." The depressive side is grounded in a way it wasn't in the manic stage," said Peter Kuriloff, a University of Pennsylvania professor. "It's anxiety about other possible attacks, about questionable earnings reports, about people's jobs." And people who are employed are feeling hemmed in, compared to when unemployment was at 3.9%, Kuriloff said. "Everyone was confident they could bounce into whatever job they wanted, and all of a sudden they're stuck in their company. That is depressing, that lost sense of freedom." And then there's our hammered 401(k)s. "All these people were deferring current consumption for future consumption, and suddenly, elements of that choice go up in smoke," Kuriloff said. "It's not just the loss of money, but what it stood for come retirement - visiting grandkids, traveling." "Money is symbolic of independence, power and esteem, so it's not really the loss of money that depresses us, but the associations that go with it," Geist said. So how do we kick back and smell the roses, the coffee, even just a whiff of fresh air? "While everyone around you is feeling depleted and empty, look at companies to figure out what you'd buy when time is right. That kind of planning pulls people back into a competent mode. It allows us to de-center from our emotions and put our intellectual capacities to work to recover from this psychological injury," Geist said.
Banks were specialist lending institutions, with access to credit information and the ability to analyse it. But banks charged a fee for this role, in the form of an interest rate mark-up. Banks came into existence in the first place because of two features of the market for credit: transaction costs and asymmetric information. From the 1970s onwards, those two drawbacks to disintermediated lending lessened, with powerful effects on banks and their clients. Transaction costs - the expense of handling an individual provision of credit - had fallen, thanks to computers. Asymmetric information was a more serious risk until standardised information became easily available to potential lenders, which put non-specialist lenders on the same footing as banks. High quality consolidated financial statements were filed with government agencies. Steadily improving accounting standards were overseen by government-blessed bodies. Credit rating agencies had a proven methodology for assessing corporate risk. Electronic systems made it easy to assimilate this information and turn it into knowledge. Sophisticated cash and derivatives markets were capable of processing all these inputs and reflecting them instantly in risk premiums. Borrowers and lenders were able to avoid the banks' charges, splitting the difference between them. Now think of Enron and Global Crossing and re-read the previous paragraph. Suddenly, those innovations that redressed the information asymmetry no longer look so effective. Although the amount of commercial paper owed by financial institutions has remained steady, the paper outstanding from non-financial businesses has dropped 36% in 14 months. Partly this reflects the economic cycle, as companies slash borrowings and cut back on credit lines that they no longer need to finance their newly slimmed-down inventories. But partly it must reflect a change in the credit climate. Tight Credit Part 1 Jennifer Ablan, Barrons 2-25 The first quarter is likely to mark the 16th consecutive quarter of debt downgrades exceeding upgrades, closing in on the 1990-91 record of 19 straight negative quarters. The global default rate for speculative-grade corporate bonds rose slightly to 10.4% in January from 10.3% in December. And more than a dozen firms have lost their top-grade Prime-1 commercial paper rating so far this year, with the same number on watch for possible downgrade, according to Moody's. The steep slump in revenues, excess capacity worldwide, intense competition and lower producer prices have soured credit quality, with the September 11 attacks and accounting concerns stemming from the Enron collapse compounding the problem. Junk bond issuance peaked at a record $140 billion in 1998 from $113.1 billion the previous year, according to Thomson Financial data. But after the frantic search for yields in 1997-98, which lured money managers into some dubious investments, trouble started. Last year, junk bond issuance was $76.3 billion, with only $9.9 billion so far this year. For investment-grade debt, the market has seen about $76.7 billion so far this year. Compare that with last year's record-breaking year for high-grade at $638.5 billion. Capital expenditures for the biggest bond issuers are budgeted to be down in 2001 versus 2000 - the first decline in over a decade. In addition, actual share repurchases - another big drain on balance sheets since the mid-1990s - will be running at a multiple-year low among big bond issuers. Some 38 firms lost their top-grade Prime-1 short-term ratings last year and more than a dozen so far this year - the most since 1990-91. For the first time last year, the amount of asset-backed CP outstanding surpassed unsecured corporate CP, said Moody's Investors Service, in an annual report in January. Asset-backed CP outstanding reached around $745 billion, compared to $695.6 billion of unsecured corporate CP. Moody's is expecting issuance this year to total around $825 billion, which represents about 11% growth for the year, down from last year's 16% growth and the previous year's 20% rate. Tight Credit Part 2 Greg Ip, WSJ 2-27 "There is an unfortunate structural decrease in the availability of credit on even terms in this recession," National Association of Manufacturers President Jerry Jasinowski says. It's "a trend that undermines the recovery." An association survey of small- and medium-sized manufacturers found 34% said credit is harder to get compared with last year, while 6% said it is easier. The remainder saw no change. Federal Reserve surveys of bank-lending officers have also found that banks have been tightening lending standards on commercial and industrial loans since the second half of 2000. While the rate of tightening slowed a bit in the January survey, it remains faster than in the last quarter of the 1990-91 recession. Banks' commercial and industrial loans have been shrinking for the past year while their holdings of securities such as Treasurys have grown. Bank mergers and banks' efforts to channel lending activity to their investment-bank affiliates have played a role. However, a recent FDIC study said business credit has grown faster than in previous recessions, when all types of credit, including corporate bonds, are added together and adjusted for inflation. Furthermore, some of the decline in bank lending is because of less demand, not supply, Fed surveys indicate, as companies pare inventories and expansion plans in response to weak sales. Though the recession was mild in terms of declining GDP, it was among the worst for profits. Goldman estimates that cash flow is at its lowest relative to debt since World War II. Furthermore, before the recession, businesses had been drawing on outside funds to an exceptional degree - equal to 3% of GDP - to finance their investment, leaving capital-spending plans especially vulnerable to lender recalcitrance. Goldman estimates that though the "financing gap" between cash flow and capital spending has narrowed, it remains wide by historic standards. "This means the path to a resumption of capital spending will be a slow one rather than a fast one," said Goldman economist Ed McKelvey. Capital Spending Caroline Baum, Bloomberg 2-25 In the past month signs of recovery have begun to sprout up all over, even in the area of long dormant capital expenditures. New orders for non-defense capital goods, a barometer of future capital spending, rose in October, November and December. It was the first time non-defense capital goods orders logged three consecutive monthly increases since late 1999 into early 2000.
"Yes, we're seeing a slight uptick," said Jeffrey Joerres, chairman and chief executive of the Milwaukee staffing company. "But we're still at a very low hiring intention." In some industries, he said, hiring prospects are at levels last seen in the 1991 recession. Overall, 21% of the companies surveyed said they planned to add workers, while only 10% said they planned to cut employment.
Some economists have been arguing that business investment actually is starting to turn around. According to the Federal Reserve, production of business equipment rose in January for the first time since August 2000. Orders of high-tech gear have shown signs of gaining after collapsing last year. And the Institute for Supply Management's monthly factory index suggests that manufacturing has stopped contracting. "All of that is pointing in a positive direction," says John Lipsky, chief economist for J.P. Morgan Chase.
No. 1 on the list was Dell, whose sales have increased from less than $1 billion to more than $30 billion in a decade. No. 2 Emulex makes sophisticated connectors that speed the storage of electronic data. The performance of the 20 stocks was astronomical. Dell's stock price, for example, increased by 7,890%. In other words, an investment of $1,000 grew to $79,900 in 10 years. Even the No. 19 stock, Intel Corp., rose 1,668% - not including dividends, which alone rose by a factor of 10. Why did the stocks rise? Mainly for the most old-fashioned of reasons: Their profits rose. The average annual increase in earnings per share for the 20 companies was 34%; the average annual increase in stock price was 41%. But what do these huge winners tell us about P/E ratios? "What's interesting," writes Moe in a letter to his clients, "is that the average P/E of the top 20 was almost 30 at the beginning of the 10-year period." In fact, six of the companies had P/Es in 1991 that were over 40. A reasonable conclusion is that a high P/E is no reason to eliminate a stock. By the way, average P/Es rose to 48 by 2001, an indication that investors still think these firms will do well in the years ahead. Another important fact gleaned from the list, however, is that only three of the 20 were unprofitable in 1991. One of my rules is never to buy stock in a firm that hasn't made money. You can wait and still make a bundle. In 1991, for example, Cisco, at age 7, was earning $43 million on $187 million in sales. And don't forget that non-techs can be monster winners, too. On Moe's top-20 list were Clear Channel, radio; Best Buy, retail; Robert Half International, personnel; Harley-Davidson, motorcycles; and Jeffries Group and Eaton Vance, finance. In general, tech is where the action was in the past decade and where it will probably be in the decade ahead. Just remember that the action is wild. Go ahead and search for a few big winners, but protect yourself through diversification -- own lots of tech stocks, but keep only about one-fifth of your total stock assets in tech. Don't go overboard on tech, but don't neglect it, either.
With the sudden passion to discover what was real and what was fake about corporate earnings in recent years, some economists are comparing two broad measures of results: the "operating" earnings figure for the blue-chip Standard & Poor's 500 index, and total U.S. after-tax corporate profit as reported in the government's "national income and product account" report, or NIPA. Operating earnings data have been manipulated in recent years to the point where no one is exactly sure what they mean. The NIPA results, by contrast, are based on information reported to the IRS by all incorporated businesses, public and private. Both NIPA earnings and S&P earnings surged between 1992 and 1997. But then the NIPA results stalled out, while the S&P results continued to rocket from 1998 through mid-2000. Since mid-2000, both measures have been plummeting. But why should the S&P companies have had dramatic profit growth from 1998 to 2000 while total U.S. corporate profits had stalled? It may have been that the biggest companies simply did a far better job of running their businesses in that period, compared with most other public and private companies. Post-Enron, though, many analysts believe that strong S&P operating profits were at least somewhat illusory, thanks to many perfectly legal accounting tricks and some that were either illegal or borderline. With the recession, the discrepancy between S&P operating earnings and the bottom line for those companies after including all "special" write-offs and charges widened dramatically last year. In Q3, S&P operating earnings were down 14.5% from a year earlier, says economist Edward Yardeni, chief investment strategist for Prudential Securities. But S&P results including all special items plummeted 47% from a year earlier. Steven Wieting, economist at Salomon Smith Barney, notes that while total write-offs recorded by S&P 500 companies last year were equal to nearly 45% of operating earnings - non-cash charges recorded by just two telecom companies, Nortel and JDS Uniphase, made up almost one-third of the write-off total. The Nortel and JDS charges were for "goodwill impairment." Companies must immediately write off assets that they know are worth far less than their value on the balance sheet. For Nortel, JDS and others, that has meant writing off goodwill, which essentially is the amount they overpaid for what have turned out to be bad acquisitions made during the boom years. In aggregate, those goodwill write-offs "could wipe out all reported U.S. earnings on the mistakes of just a handful of companies," Wieting said. Surely, he argues, it wouldn't make sense to price the market overall based on those bottom-line results. Most investors must agree, because stock prices, while under pressure again this year, obviously haven't collapsed across the board. Scott Grannis, economist at Western Asset Management, cautions against becoming too pessimistic about earnings potential. Investors, however, may only have begun the process of re-evaluating what is "genuine profitability," and deciding how high a stock price they want to pay for their slice of that profit.
To demystify these special items, think about mortgage applications. In order to get approved for a mortgage, you've got to go through a strip search. They don't care that you make $100,000 and donate money to your church. They're much more interested in the high-flying balance on your credit card. So wouldn't it be great if you could create a little mini-me and have him apply for the loan? Just give mini-me the $100,000 a year job. Nothing else. No credit debt. With a clean slate, the banks will be throwing money at mini-me. Humans can not clone - but corporations can create a "mini-me" of its own, a special-purpose entity, and apply for cheap financing. Let's assume a company needs financing for a new product. Because of the already existing debt on its balance sheet, the banks may loan the money at a hypothetical interest rate of, say, 8%. That interest rate makes the chief financial officer flinch. So, instead of applying for the loan itself, the company sets up a special-purpose entity. Think of the SPE as a trust. To establish this trust, the company must sell the SPE an asset - any of the ones listed on its balance sheet will do. In this case, it sells its receivable balance and therefore must remove it from the balance sheet. The SPE pays the company for the receivables with the money it collects from these new investors and the company gets to beef up the cash section of its balance sheet. With only one asset on its books, investors won't be hard to find. Even better, they're willing to accept a lower interest rate because it appears that the repayment of their loan is a pretty sure thing since the SPE has no other debt. So everyone is happy, right? The firm just got a lower interest rate for the money it needs to finance a new project and the new investors locked into a reasonably safe loan. Well don't forget about the company's creditors. They aren't all that thrilled with the fact that the company sold off one of its assets, especially if it did so at a loss. Now how are they going to get paid? And, anyone who looks at financial statements may be a little perturbed by this arrangement. In many instances, we'd like to see that debt reported on the company's balance sheet. But as long as the company is not liable for the SPE's debt, FASB allows the transaction to be reported off-balance sheet. To be more specific, at least one SPE investor needs to put up at least 3% of the SPE's equity. The company can contribute the rest and still qualify for off-balance-sheet treatment. In some instances though, the company offers to guarantee the SPE's loan. Enron guaranteed some of its SPEs debt with its own shares. But even in that case, the accounting rules still do not require the company to report that on its balance sheet. It just needs to disclose that guarantee in the footnotes. This is the where the abuse comes in. Some companies use these entities purposely to keep debt off its balance sheet. Are SPEs only for Crooks? Hardly. Just about every major company uses them - especially to get cheap financing, and, in some instances, there are tax perks to using these things as well. Of its $500 billion in assets, GE has around $55 billion in SPEs. And that SPE debt appears justifiable. NOTE: this is part two of a series on off-balance-sheet items. Part one is toward the bottom of this page
But for many Global Crossing executives, the outcome has been quite different. As the company, which never turned a profit, headed for bankruptcy, some of these executives fared far better. Global Crossing's new CEO received a $3.5 million signing bonus when he took the job in October - even though he was already employed as CEO of Asia Global Crossing, a separately traded affiliate. At about the same time, Asia Global Crossing and Global Crossing forgave a $10 million loan to him, and Global Crossing eased the terms of an $8 million loan to its departing chief executive. The company also moved up its last pay date by a week so that executives and others still employed at Global could get paid before the company declared bankruptcy Jan. 28. Severance payments to the already laid-off workers weren't paid. Furthermore, in recent months Global Crossing made 11th-hour lump-sum pension payouts totaling $15 million to high-ranking executives, most of them no longer with the company. As the stock fell from its high of $64 a share to 30 cents before the company filed for bankruptcy, the value of employees' 401(k) plans fell by as much as $200 million to $8.9 million as of Dec. 2001.Top executives, however, generated a total of $1.3 billion in stock sales from 1999 through last November, government filings show - an amount that exceeds even the insider sales at Enron. Michael Conway, an attorney who represents former employees in the Global Crossing bankruptcy, says many workers are owed $50,000 to $100,000 in severance. Global Crossing says it was legally required to cut off severance and medical benefits when it filed for Chapter 11 protection.
Stephen Cecchetti, former director of research at the New York Fed and professor of economics at Ohio State University, is another one who isn't sanguine about inflation and does the math to illustrate his point. Services account for 70% of the core CPI. Assuming stability in core goods prices (the other 30% of the core index) and a 4.6% increase in core services, `simple arithmetic leads to my troubling conclusion that inflation is on its way over 3%,' Cecchetti says. He goes on: `I simply do not subscribe to the notion that the slowdown has somehow generated enough slack to force inflation down over the next year. I see no evidence in the inflation statistics to suggest that service price inflation is somehow declining. In fact, most of the information we have available is pointing the other way.' Cecchetti has a point. Shelter costs, which make up 31.5% of the CPI and a massive 40% of the core index, rose 4.1% in the year ended January. Given the lag with which shelter costs track the Office of Federal Housing Enterprise Oversight's Housing Price Index, and given the HPI rose 8.4% in the third quarter from a year earlier, relief from the CPI's biggest component may be a ways away.
"There are people who will not part with their stocks or mutual funds until they break even, because it's just too painful," explains Meir Statman, a finance professor at Santa Clara University in California. Those who bailed in 1988 and early 1989 paid a steep price for their skittishness. Stocks soared 31.5% in 1989 and went on to generate glorious returns through the 1990s. Many folks, I suspect, will make the same mistake this time around. They will dump their stocks as soon as they recoup their losses, thus abandoning any chance of earning a decent reward for their stock-market suffering.
The employer assumes the financial risk of providing benefits to employees in exchange for greater control and potential savings. It sets up a reserve or trust fund to pay those claims. Self-funded insurance has long been used by large multi-state employers that can manage the risk of heavy medical claims better than smaller companies. About two-thirds of the nation's largest employers employ some form of self-insurance, experts say. The big employers also avoid a bewildering array of state insurance regulations when they self-insure and avoid insurance premiums and taxes. But now many mid-size and smaller employers also are willing to take on the risks of self-funding. And with costs of health maintenance organizations rising as fast as or faster than traditionally more expensive health plans, the percentage of employers that are self-funding their HMO coverage also is on the rise, having climbed from 6% to 13% from 2000 to 2001, according to a survey by William M. Mercer. Virtually every form of self-funded insurance is federally regulated under the Employee Retirement Income Security Act. That's one of the reasons large employers prefer self-funding, because it alleviates the need to follow various state regulations.
SimulCam uses computer sensors on two cameras that collect information on the cameras' panning, tilting and zooming. The video information captured by the sensors is stored in a computer where the software blends both backgrounds and isolates the performers. In the final product, the skiers become semitransparent as they near each other, opaque as the distance between them increases. The concept of comparative replays offers a wide range of possibilities in the Olympics and beyond. Want to compare Randy Johnson's pitching motion to Al Leiter's? Or examine the difference between Tiger Woods's motion on a soaring, splendid drive with his swing on a badly hooked drive? Already, athletes use a slightly different, nonbroadcast version to compare their slumping selves to show how they looked at their peak, or how they performed from one ski run to another. Conceivably, the technology could eventually enable a football coach to compare the pass releases of his quarterbacks or even to compare the skills of two potential draft picks. More on SimulCams Jeffrey Benner, Wired 2-13 The Simulcam technology made its broadcast debut in 1999 during coverage at the World Championships for skiing in Vail, Colorado. The technology caught the eye of U.S. ski team coaches, who saw it as a potentially powerful tool for fine-tuning a skier's performance. In the three years since, the software, produced by Dartfish, has taken the Olympic sporting world by storm. Ski teams from the United States, Austria, Germany, Switzerland and Italy all use it. A year ago, the U.S. Olympic Committee Sports and Science Division in Colorado Springs created a special new "performance technology" department to integrate the Dartfish video and software technology into training for all 43 Olympic sports. Aside from the Simulcam, the company's other major technology is Stromotion. Featured in previous figure skating coverage, it produces a trail of images, creating a frame-by-frame history of a triple loop, for example, in a single image. NBC elected not to use this feature for its Olympic coverage. But coaches have been using it to help skaters, freestyle skiers and snowboarders perfect their acrobatics. SimulCam's other uses? Joanne Ostrow, Denver Post 2-15 How about a sitcom SimulCam? (The SimulSitCam?) NBC's comedies could use the SimulCam technology to show viewers how much the cookie-cutter ensemble shows borrow from one another. Layer one contrived, vacuous Thursday night post-"Friends" comedy over another and see how they pace themselves through set-ups and laugh lines in near-perfect sync. Like skiers edging through gates, sitcom writers hit the predictable notes and required number of chuckles between commercials. Or maybe broadcasters could develop a local SimulNewscastCam, which would enable viewers to observe the creepy similarities in news shows on different stations. We could overlay newscasts to judge how similarly they are reported, how alike the reporters look and even the similar placement of stories within the news lineups. There must be a way the Olsen twins can work a SimulCam scene into their next movie to make an even more lucrative quartet of themselves.
Suppose you had joined X Co. 10 years ago and had invested $100 a month in X Co. shares, increasing your investment 4% each year as your income rose. How much would your investment be worth today? How you did on company stock depends on the stock, not your persistence or regularity. Nor does it depend on your industry. Employees at Dell would have ended with $332,944. The same program ended with $18,040 at Compaq. Southwest Airlines employees ended with $42,842. Those at AMR ended with $16,785. Employees at energy trader Dynegy ended with $35,986 while employees at Enron ended with $999, a bone-breaking fall from its peak of $61,673 in September 2000. Employees at Exxon Mobil ended with $28,254. Those at Conoco ended with $4,763. Employees at Radio Shack ended with $32,130. Those at J.C. Penney ended with $14,076. If you had pursued the same investment plan with the Vanguard 500 Index fund, your investment would have grown to "only" $25,487. Still, that would have done better than 78% of its competitive peer group of managed-equity funds, according to Morningstar.
One quick take on a firm's primary investment strengths is Barron's annual ranking of fund-family performance. If you look at each of the top-performing families - Capital Research (American Funds), Legg Mason, STI Classic, Calvert, WM Group, and Franklin Templeton, it becomes clear that they lived off their strengths, namely the value stocks, small-cap stocks, and bond funds that brought the greatest returns in a dismal 2001. At the bottom of the list were growth-fund firms like Janus, Putnam, AIM, and Invesco (which finished dead last). All had been near the top when growth was in fashion. 'Look at the roots of any fund family and trace them,' says Gerald Perritt, editor of the Mutual Fund Letter newsletter. 'There is one investment philosophy, style, or strategy that they started with, and everything else built from there. 'Over time, the funds that are outside their main way of thinking always seem to be the ones that wind up doing poorly.' In the mid-1990s, as fund families grew their offerings exponentially to include every possible type of issue, investors seemed worried about convenience, consolidated statements, and the ability to move money from one fund to the next in the family with just a phone call. Many investors diversified based on a line of reasoning that went something like this: 'If one fund from here is good, two would be better.' The Barron's ranking - not to mention the losses suffered by investors in Janus, Putnam, AIM, and Invesco - should be enough to persuade investors to think twice before buying siblings. Because fund families tend to concentrate on what they do best, sister funds tend to move like a dance team, swaying in time to the same music. It's not a problem when the firm is on a hot streak, just when things turn cold. 'Good proper diversification doesn't always happen within one fund family, it may take two or three or four,'' says Tom Roseen, a research analyst at Lipper. ''The people who bought from the top fund company of two years ago - Janus - haven't necessarily found that having three funds in the family is better than having just one and putting some money elsewhere.' The bottom line is that investors need to pick funds, not fund companies. In the end, owning too many funds from the same family is not a major investment sin, but it may mean your portfolio is not quite as diversified as you expect, and maybe a bit more volatile.
Likewise collapsed is many U.S. companies' urge to merge. Deals worth $21.1 billion were announced in January, the weakest activity for any January since 1994, and a third of the December dollar volume, according to Thomson Financial. The relative dearth of buybacks and takeovers significantly dents two key sources of demand for stock. Little wonder the market is struggling this year, after the heady rally of the fourth quarter. One reason companies are buying back fewer shares is that many of their insiders have stopped exercising stock options, some analysts say. One logical reason for corporate insiders to stop exercising options would be because those options are underwater - meaning the market price is below the exercise price. What has troubled some analysts is that many companies were eager to go deep into debt to finance their buyback programs in the late 1990s. Now, that debt is coming back to haunt companies. And some recent buyback announcements have been poorly received in the market because of fears that companies risk more harm than good by using cash to repurchase shares. Neither McDonald's nor Johnson & Johnson saw an immediate lift in their stock prices last week after announcing large buyback programs. Garbage hauler Waste Management Inc.'s stock has fallen since Feb. 1, when the company said it may buy back as much as $1 billion of stock annually. Credit-rating firm Moody's Investors Service reacted to the company's plans by changing its credit outlook for the firm to negative from positive - a harsh reminder that financial alchemy that is glorified in a bull market can be viewed as poisonous when the wind changes. Related: Enronitis, Enron's Collateral Damage, Separations Increasing
Are the tiny distances between any two of these market gauges worth bothering about? Not to my eye. The kind of stocks you owned over the past 20 to 30 years quite evidently was a minor matter compared to the question of whether you owned stocks or not. Bull markets are times for developing refinements in investing, ideas like style. As long as the market is rising, these distinctions are interesting and give us a sense of increasing sophistication. Bear markets are times for stripping these refinements down again and asking whether we're using them right. At low ebbs like now, investors are pushed and prodded into going back to basics, revisiting the virtues of simplicity.
The four main items reported in the footnotes are lease agreements, pension assets and liabilities, investments in joint ventures and affiliates and special purpose entities, otherwise known as the securitization of assets. We'll tackle the first three today and save special purpose entities (or SPEs) for next week. Operating Leases Lots of companies have operating leases - there is nothing wrong with having them. But they are future liabilities that will need to be funded by future revenue. So it helps to compare. The total cash Staples would have to pay to cover its leases, which are generally over an extended period of time, is around $4.4 billion. That's around 41.8% of it's annual revenue. Is that bad? To find out, compare the figures to a peer company. Office Depot's operating leases are only 19.5% of its annual revenue. Pension Assets and Liabilities Pension assets and liabilities are not shown on the balance sheet. Since the pension assets are put into a trust, a separate legal entity, the argument is that those assets belong to the employees. But companies can manipulate them to pump up earnings. IBM recently raised the rate of return on its pension assets from 9.5% to 10%. That will increase its pension assets, thereby decreasing its pension liability and, voila, earnings go up. "Net pension liability" is found on the company's balance sheet. Let's assume there are $300 million in pension assets. But if everyone retired, the company would need to pay out $500 million. So the company is short $200 million at this time. After the go-go market of the late 90's many companies actually had a surplus in their pension funds thanks to those rocketing returns. Joint Ventures and Affiliates If a company owns a piece of an affiliate or joint venture, in many instances, it doesn't have to separately report its proportional piece of the assets and liabilities on its balance sheet. Only the footnotes need the details. If a company owns 50% or less of an affiliate or a joint venture, then only the net of the assets and liabilities the company owns pertaining to that affiliate should hit the balance sheet. In most instances, you'll find that number under the investments section. This net number is the result of the "equity method," in accounting-speak. So if our company owns 50% of a company with $10 million in assets and $8 million in debt, net assets are $2 million, assuming no goodwill. Since the company owns half, it reports $1 million as an asset in the investment section of its balance sheet. But isn't the company responsible for $4 million in debt? Why doesn't that ever hit its books? Technically, the company doesn't have to pay that debt back. The affiliate is given the benefit of the doubt that it will come up with the money to repay anything outstanding. Conclusion Doing a debt-to-equity ratio (which is long-term liabilities divided by stockholders' equity) won't cut it these days. Tally total debt but then comb through those footnotes and find the total pension liability, leases outstanding, and affiliate liabilities to name a few. Then run your debt-to-equity ratio. And be sure to compare that number to its industry peers. A Short History of Financial Statements David Wessel, WSJ 2-7 The practice of audited corporate financial statements is a modern one. U.S. Steel Corp. was a lonely pioneer in 1903 when it hired Price, Waterhouse to certify the accuracy of what's considered the first modern corporate annual report, 40 pages of narrative, numbers and photos. Other companies were slow to follow. Widespread allegations of fraud and skulduggery after the 1929 stock-market crash changed all that, prompting legislation that forced publicly held companies to submit regular reports that met certain standards. Congress first told the FTC to regulate accounting, then, in 1934, gave the job to the new SEC - which promptly delegated it to the accounting industry and, later, to an independent outfit, the Financial Accounting Standards Board. A Legislative Sea Change Floyd Norris, NY Times 2-15 A few months ago, politicians who said anything about accounting rules were lobbying to weaken them. The argument, put forth by corporate lobbyists, was that tough rules would scare investors and drive down stock prices. Yesterday, both the House and Senate held hearings on accounting standards, with legislators clamoring for action to end abuses and reassure those same investors that the numbers are not fake. Capitalizing Operating Expenses Ken Brown, WSJ 2-21 For every product or service a company sells, there are costs. Long ago, financial executives realized that if those costs could be reduced, profits would go up. So began the game of capitalizing operating expenses, which means taking the daily costs of running a business and spreading them out over time by treating them as if they are long-term assets. The cost is then written down slowly. In 1996, America Online was forced to take a $385 million pretax charge, which effectively wiped out every dollar of pretax profit the company had made over the previous five years, when the SEC ruled that the cost of those ubiquitous disks with AOL software was an immediate advertising expense, not a capitalized item that could be written off over time. Watch Cash and Receivables Monica Rivituso, Smart Money 2-19 If the amount of cash listed on a retailer's cash-flow statement doesn't keep up with receivables or sales, that could signal trouble. Why? Say a company wants to inflate income. To do this, it might report fictitious sales and receivables. But since those numbers are fabricated, cold, hard cash isn't really coming through the door. The result: a disparity between the income statement and the cash-flow statement. Investors should be on the lookout for situations when income is high but cash is low. (Remember, though, that fast-growing companies tend to be chronically low on cash for a variety of legitimate reasons.) Watch R&D at techs Monica Rivituso, Smart Money 2-22 R&D is a key area for any technology company, since future success rests on the ability to create innovative new products. Since, by nature, high-tech companies must keep R&D spending levels high, a big drop in such spending at a software company should raise a red flag, says Robert Bricker, professor of accountancy at Case Western Reserve University's Weatherhead School of Management. Why? If a company is struggling to meet projections in other areas of the business, management might decide to siphon off some of its R&D funds to make up for that shortfall. Related: Stuffing the Channel [how to check balance sheet for this accounting abuse] Just the Facts CPI Expectations On the surface, the future looks good for price stability. In the past three months, consumer prices showed no gains at all. A more cautionary tale can be read in the prices excluding food and energy. Those gains in the past year and in the past three months have been 2.6%. This means that when energy prices stabilize, inflation will jump. Food inflation should be close to core inflation, as it was this year. Energy deflation will vanish. The dollar probably will give some ground. Therefore, the plunge in clothing prices will end, and some increase is likely. That 1.1% CPI gain in the past 12 months will be replaced by one that is closer to 3% in the next 12 months. (Donald Ratajczak, Atlanta Journal-Constitution 2-24) Consumer Spending Why has consumer spending held up so well? There are several reasons. Bargains have played an important role. In past recessions, rising prices inhibited consumers. This time, the inflation rate is hardly noticeable; price-cutting has been widespread. Low interest rates have also encouraged spending. So have falling fuel prices. As rates fell, mortgage refinancing put billions of dollars into the pockets of homeowners without raising their monthly payments. The problem is that none of these factors are likely to repeat themselves. And hourly wages, while still rising smartly in the fourth quarter, have begun to show signs of faltering as unemployment moves higher. (Louis Uchitelle, NY Times 2-24) Economic-itis ?? "A few months ago we were looking for evidence that the economy had bottomed," says James Paulsen, chief investment officer at Wells Capital Management. "With the easy part of the recovery over, now it is a tougher hurdle. We are looking for evidence that the economy is going to go back to a 3% to 4% growth rate." As a result, there is a potential risk if reports over coming months show that the economy isn't reaching that rate, he says. If by the summer, the economy fails to show signs of getting back on track after one and a half years of the Fed's most aggressive interest-rate easing periods, there will likely be concern about "the Fed's potency," says Paulsen. That could trigger "economic-itis, like we are in Enron-itis now." (Cassell Bryan-Low, WSJ 2-24) Now You Know . . . "I remember the day my nephew got his first paycheck. He was excited and had all kinds of plans for his newfound wealth. As he began to examine the stub, he yelled out: "Aunt Michelle, what the heck is FICA and where is all my money? I've been robbed." "No, Tom," I said. "You've been taxed." I think it's appropriate that we refer to the document attached to our paycheck as a pay stub. "Stub" is defined as something cut short or stunted. FYI: 'Fed MED/EE' is the 'Federal Medicare Employee Employment' Tax (a.k.a. Medicare) and is 1.45% of your taxable income. The 'Fed OASDI/EE' is 'Federal Old-Age, Survivors and Disability Insurance Employee Employment' Tax (a.k.a. Social Security) is 6.2% of the first $84,900 of your wages. (Michelle Singletary, Washington Post 2-24) CEOs Don't See Upturn Yet While economists are looking for a more rapid U.S. recovery than they were a month ago, chief executives at Wal-Mart, Dell, Eaton and most of the biggest companies don't see it. Corporate earnings are a lagging indicator, improving only after the economy has begun to pick up. Companies are likely to report their fifth straight quarter of declining earnings in the first quarter of 2002, according to Thomson Financial/First Call. Chuck Hill, director of research at Thomson Financial/First Call, said there's about a three-month lag between when the economy starts to turn and when chief executives begin to see evidence in the bottom line. (Bloomberg 2-22) Stock Funds' Inflows for January Stock mutual funds took in $3.1 billion in new money from investors last month, the smallest increase for a January since 1991, according to estimates by research firm Lipper. Investors poured $9.4 billion in new money into bond funds and parked $15.9 billion in money-market funds last month. Widely diversified U.S. stock funds collected a total of $5.2 billion in net new sales, partially offset by $1.6 billion in withdrawals from sector funds, Lipper estimated. World stock funds were another losing category, with net withdrawals of $2.8 billion, according to Lipper. (WSJ 2-21) Hedging Often Off Radar Enron director Robert Belfer took steps to protect some of his Enron shares against steep price drops from November 2000 through October 2001. Amid heightened investor awareness about what executives and directors are doing with their own company shares, such hedging maneuvers often are off the radar screens of shareholders. Yet experts say that hedging strategies designed to limit an individual's downside risk in stock are becoming increasingly common. Mr. Belfer collared (purchase of a put option and offsets that cost with the proceeds from the sale of a call option) about one million shares, valued at $81.2 million at the time, locking in floor prices of between $55.53 and $65.70 before Enron's stock price began its free fall. (WSJ 2-20) Credit Crunch More and more companies are finding their creditworthiness in question. In January, debt-rating agency Moody's downgraded 54 companies and upgraded only 12. Companies with less than stellar credit appear frozen out of the commercial paper market and have had to resort to tapping backup lines of bank credit, which come at higher prices. As of the third quarter of 2001, 27 cents of every dollar in corporate cash flow was going to cover interest payments, according to Economy.com. That's up from 19.9 cents of every dollar in 1996. Higher interest payments mean lower profits, which in turn could cause investors to shy away from stocks. (Neusner, Lim & Pethokoukis, US News 2-18) Unemployment Stats On Thursday, the Department of Labor published its preliminary estimate of new unemployment insurance claims for the week ending February 9. The four-week moving average of weekly claims actually declined a bit further to 376,000 from 381,500 the week before.The four-week average of initial claims has been running 0.27% of the labor force, which indicates a topping out of the unemployment rate if not a small decline; based on past trends, 0.30% is about "neutral" for the jobless rate. (Gene Epstein, Barrons 2-18) Mutuals & Taxes Did you know that every year 2.5 percentage points of the total return in the average stock mutual fund is lost to taxes? What does that mean in real numbers? Here's an example. Suppose you had $10,000 to invest and you bought shares in a mutual fund that had an annual return of 10% over a 10-year period. At the end of the 10 years, you would have $25,937. If you lost 2.5 percentage points each year to taxes, your balance would be reduced less than $21,000 [ .. to be specific, it is $20,610 - or a total loss over the 10 years of $5,327 to taxes. Instead of having a $15,937 gain, you have an after-tax $10,610 gain. ]. (Michelle Singletary, Washington Post 2-17) Biotech Update There are about 380 public biotechnology companies. Last year, about 32 companies were profitable, of which 10 to 15 are well known. We think 45 will be profitable this year. In 1990, there were only about 100 drugs that were in clinical studies, only 10 drugs were on the market, and revenues were about $2.8 billion. By 2000, 370 drugs were in development, 92 were on the market and revenues were $18 billion. By 2005, we are looking for 800 products in human clinical trials, 197 on the market and revenues of close to $50 billion. That's top-line growth of close to 21%. The average company spends between $500 million and $800 million to get their drug on the market. And for every five drugs that get into human clinical studies, only one ever makes it to market. The names I am recommending are Idec Pharm, Gilead Sciences, Cephalon, NPS Pharm, Cell Therapeutics and Intermune. (Eric Ende, a medical doctor and a managing director at Banc of America Securities, NY Times 2-17) Men's Fashion Update "When given the chance, a guy will fall to the lowest common denominator when it comes to his clothes" says David Smith, owner of Pockets Menswear. But things are changing. Manufacturers and retailers say that some are upgrading their casual clothes. For casual shirts and pants, nicer fabrics are becoming widely popular. One reason to expect a small return to suits and jackets is that men have been befuddled by 'office casual'. Dressing down got to be more difficult than dressing up. Men's psyches don't work well with all that. Men's suits prices have dropped 12% in the last five years. When off-price sales are thrown in, the decline exceeds 20%, said Marshal Cohen, president of NPDFashionworld. (John Kirkpatrick, Dallas Morning News 2-16) Unavailable Drugs About 40 drugs or vaccines are currently unavailable or in short supply, according to a list posted on the American Society of Health-System Pharmacists. "Five or six years ago, there were eight or 10 shortages a year," says Linda Tyler, director of the University of Utah drug-information center in Salt Lake City. "Last year, there were about 30. This year, we've had 40 new shortages and it's only April. Something is absolutely spiraling out of control." There are several reasons for the shortages. Sometimes, drug companies simply decide to stop making a drug because they don't make enough money off it. In other instances, a crackdown by federal health officials on manufacturing problems leads to production delays and shortages. Although doctors faced with a shortage can almost always find an alternative, they often aren't as familiar with the way those substitutes work, or the potential side effects. (Tara Parker-Pope WSJ 2-15) Loans Hide Abuses More than 25% of large companies give their executives loans, according to William M. Mercer, a consulting firm. Perhaps the biggest problem is disclosure of, or rather nondisclosure of, the stock-for-loans swaps that hundreds of executives make every year to repay debts, governance experts said. The loans can, for example, keep shareholders from knowing when executives are selling large numbers of shares in their own companies, as happened at Tyco. The loans can give indebted executives an incentive to pursue unusually risky strategies to rescue a falling share price. And when a stock price does not recover, the deals can ultimately cause boards to write off millions of dollars of bad loans to keep executives out of bankruptcy. (David Leonhardt, NY Times 2-3) Quick Facts, Stats & Opinions The rapidity of Enron's decline is an effective illustration of the vulnerability of a firm whose market value largely rests on capitalized reputation. Trust and reputation can vanish overnight. A factory cannot. (Alan Greenspan 2-27) The average individual income-tax refund through Feb. 15 is $2,210, up 12%. The total dollar amount of individual income-tax refunds surged 15% to about $50.57 billion. The IRS cites three main reasons. "Changes in the law affecting tax rates and the child tax credit joined the annual inflation adjustments in helping produce the refund jump," a spokesman says. (WSJ 2-27) "If the market keeps digging [for accounting abuses], it won't like what it finds, and that means bad things for the market as a whole," says Tim Kelly of Dresdner RCM, manager of Safeco Small-Cap Growth. Smaller companies, on average, have simpler financial statements and balance sheets, and less of the number-massaging "sophistication" of large-company CFOs. (Michael Santoli, Barrons 2-25) The research firm Strategic Insight calculates that stock and bond funds last year distributed less than $40 billion in taxable gains, down from $325 billion in the 2000 tax year. That amounted to less than 1% of assets in these funds, the lowest percentage of distributions in 20 years. (Michael Santoli, Barrons 2-25) In 2000 and 2001, stocks in the S&P 500 index that distributed dividends climbed a cumulative 10.2%, compared with a decline of 15% for those that did not. Consistent dividend payers also have strong long-term records, according to a recent study by Standard & Poor's. It found that they outperformed the S&P 500 from 1991 to 2001, rising fourfold, versus threefold for the index. (Virginia Kahn, NY Times 2-24) 'We estimate that last year, the return on assets for credit card companies increased by about 10% to 15%, despite the fact that personal bankruptcies went up 20%. Some of the companies had a much stronger year than they did in 2000. That is because 80% of their revenues come from lending money, and their interest margin on loans widened during the year as interest rates declined. They were helped more by widening margins than they were hurt by rising bankruptcies.' - From Robert Hottensen, financial services analyst at Goldman Sachs. His picks - MBNA and American Express. (Kenneth Gilpin, NY Times 2-24) Stock analysts are far more positive than they were a few months ago, says Joseph Cooper, a research analyst at Thomson Financial/First Call, which tracks analysts' earnings estimates. "We hit a bottom in November in terms of analysts revising estimates down," he says. "They are not trimming them by as much, or as often." (Cassell Bryan-Low, WSJ 2-24) Many investors want to believe the pall will dissipate quickly. But history suggests that they are too optimistic. The last time a big, well-known company collapsed as fast as Enron was in 1973, when the Equity Funding Corporation of America, supposedly a fast-growing insurance and mutual fund company, was found to be riddled with fraud and fell apart in weeks. When the company filed for bankruptcy on April 5, 1973, the S&P 500 was at 108.52. Nine years later, it was 114.73. (Alex Berenson, NY Times 2-24) "People are generally improved by recessions, we think. Red-suspendered analysts learn a little humility. Spendthrift consumers rediscover frugality. Greedy investors find happiness in 5 percent returns. . . . Tuition comes at a price, of course, as does anything worth learning. People suffer a little in the cause of higher financial education, but usually emerge strong, nobler and more solvent." (Bill Bonner, Strategic Investment via Washington Post 2-24) Consumer inflation rose 0.2% in January. For the 12 months ending in January, consumer prices rose by just 1.1%, the smallest increase since the 12 months ending December 1986. (AP 2-20) The latest standings, as supplied by Phoenix Investment Partners: `The annualized rate of return for stocks, excluding inflation, from 1926 through 2001 was 7.7%, far exceeding bonds (2.2%) and Treasury bills (0.8%).' Remember, that's measuring from the back side of a bad bear market. (Chet Currier, Bloomberg 2-19) Because E*Trade sponsored a promotion with the Kellogg during the bull market, offering $100 bonuses for opening accounts to buyers of Smart Start cereal, shouldn't the company now sponsor a similar promotion with General Mills, offering bonuses to anyone holding Enron stock in those accounts if they also buy Trix? (By Stuart Elliott, NY Times 2-19) The recession is not over. The National Bureau of Economic Research acknowledged that most of the indicators they use to measure such events were continuing to fall. All four major measures of current economic activity - inflation-adjusted business sales, industrial production, employment and inflation-adjusted earned income - fell in January. (Donald Ratajczak AJC 2-17) We continue to see difficulty in the sub-prime finance area as delinquencies are picking up markedly. We believe our financial shorts of JP Morgan Chase, Americredit, Metris, Household Financial, American Express, Citigroup and Bank of America will be 'home runs.' (David Tice, Strategic Investment via The Washington Post 2-17) In addition to negative chart patterns, there are other clues pointing to a weak market, such as the underperformance in technology shares. In the past, technology stocks have led other stocks higher. Ditto for the financials like banks and brokerages. As long as these leaders lag, any rally attempts will likely fizzle. (Dan Sullivan, Chartist Mutual Fund Letter via The Washinton Post 2-17) Global Crossing hasn't seen lawmakers rush to return money, despite its parallels with Enron. Democrats got about 55% of its $3.6 million since 1997, says the nonpartisan Center for Responsive Politics. (WSJ 2-15) The House GOP campaign committee Thursday sent $750 it had accepted from a convicted sex offender to a victims' fund; the Virginian's record surfaced after he was picked to get a "Republican of the Year" award. (WSJ 2-15) Since the beginning of 2000, nearly one of every five U.S. stocks has fallen by two-thirds or more, while only 1% of diversified stock mutual funds have swooned as much, according to Morningstar. Lucchetti and Francis, WSJ 2-15) The number of Americans with million-dollar incomes more than doubled from 1995 through 1999. The percentage of their income that went to federal income taxes, however, fell to 27.9% in 1999, from 31.4% in 1995. Those making a million dollars or more, one of every 625 taxpayers in 1999, more than doubled their slice of the nation's income to 11.2% that year, from 5.4% in 1995. The incomes of Americans who made less grew as well, though by far less, and the share of their income that went to taxes rose slightly to 12.8% from 12.5%. (NY Times 2-7) Quick Tips Can you protect friends from spam when forwarding e-mails? Yes. Protect yourself and your friends by removing ALL addresses when you forward e-mails. Use your mouse to highlight the addresses showing in the message body, and hit delete. Another way NOT have their names appear - use the BCC field instead of the TO field for all your recipients. It works the same, but the e-mail will show "undisclosed recipients" instead of your friends' name and e-mail address. (Prodigy E-mail FAQ page) Moving large files from one PC to another can be a thorny problem. But now, there's a new gadget for moving big files around - something called keychain memory devices. They are small, light gizmos about the size of a key, with a standard USB plug on one end. Inside, these things are packed with "flash" memory chips like those used in digital cameras and music players. To use a keychain memory module you just plug it directly into a USB port. A little green light built into the device flashes when the module is in use. In seconds, the computer recognizes the keychain memory and treats it as a disk drive, with a name or letter assigned to it. You can then save files to it or copy from it. M-Systems makes the DiskOnKey, the leader. JMTek makes the USBDrive. And Trek2000 makes the ThumbDrive. Prices change frequently, but a 64-megabyte unit is around $99 and a 128 MB unit about $180. The devices start at $30 to $50 for eight or 16 megabytes. (Walter Mossberg, WSJ 2-21) Although there are a number of ways to scroll through a Web page in Explorer (Page Down, Page Up, use the mouse, etc.), one of the easiest is to simply press the Spacebar. Pressing the Spacebar scrolls down a page. If you need to scroll up a page, press Shift + Spacebar. (Emazing 2-15) Home Page Previous Factoid Top Sites
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