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FROM THE MISERY
JANUARY 12, 2009 I WWW. FORBES. COM
CEO ROBERT GREIFELD
who get paid based on what, and how
much, they sell. That includes the legion
of stockbrokers and insurance agents
whose income takes the form of commis-
sions on financial products.
"You weed out so many problems if
you remove the conflicts of interest, " says
Mary Malgoire, president of Family Firm,
a Bethesda, Md. fee-only financial adviser.
BEYOND THE BALANCE SHEEWT
Among the nations 600,000 financial
advisers, only l2,00() could potentially
qualify as fee-only, according to Ellen
Turf, chief executive of" the National Asso-
ciation of Personal Financial Advisers.
NAPFAs members charge by the hour
(typically $ 180 to $300), work on retainer or
charge a percentage ofthe assets they advise.
Malgoire at Family Firm charges a faidy stan-
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dard 1% a year for first $1 million, with the
rate falling to 08% for sums up to $3 million.
Britain's Financial Services Authority
last month announced it plans to require
that investment advisers make a “distinc-
tion between independent advice and
sales advice. ” The FSAs aim: "removing the
possibility of commission-bias. " Chalk one
up for investors. F
Tough times encourage weak companies to get creative in coming up with
earnings gains. Knowing the tricks can save you a bundle By Jack Gage
AN INVESTORS TRUST 'THE NUMBERS THROMW AT
them? Evidently not, to judge from nearly simultane-
ous accusations of fraud against a distinguished
lawyer and a famous stock trader. But it's not just out-
right speculations that you have to wony about. It's
the risk that reported earnings are stretched or fudgcd.
As tough times take a toll on corporate performance, pres-
sure mounts on managers to fill the breach with creative account-
ing. So, with help from the Los Angeles firm Audit lntegrity, we
took a look at what makes for high-and low-quality in an
earnings figure. M's analysis encompasses a range of
numerical and qualitative assessments of whether a com-
pany's earnings could be getting an artificial boost or are
otherwise at risk of crumbling apart.
All these are black marks in Als book: lots of good-
will (which might get hit with an impairment charge),
high deferred taxes (which drain cash down the road,
when it's time to pay the IRS), pileups in receivables or
inventory (which drain cash right now), executive
pay tilted heavily to options (which provide temp-
tations to inflate earnings) and unfunded pension
You don't have to be a short-seller
to profit from M's analysis.
Companies that get high marks
for earnings quality and that * l
are also trading at low multiples
of those earnings can be unloved
Among M's top-rated companies (see table
p. 50) is CenterPoint Energy. Although the stock is
off its October lows, the $11 billion (sales) Houston natural gas
i; T” ' i
* 'n ' *På
Points pension obligation as a proportion of total liabilities was
31% below the average reported by its utility peers. On a Nov. 5
earnings call with investors, CenterPoint committed to either
maintaining or increasing its 57% dividend.
Callaway Golf and Continental Resources also receive high
marks for earnings quality and trade below the markets average
16 times 2008 eamings.
Among the companies Audit Integrity has warned investors
to steer clear of is faddish shoemaker Crocs. Audit Integrity
noticed that Crocs inventory was piling up, flagging the
trend in August 2008. Three months later Crocs
announced it would give the value of its inventory a
30% haircut in the third quarter and slash fourth-
quarter sales guidance 40% below analyst expecta-
utility still trades at a modest ten times 2008 earnings, which is a
37% discount to the 58:? 500 multiple. As of Sept. 30 Center-
tions. That sent its stock into a one-day 45% tailspin.
even as the broader market rose 7%.
One company raising Audit Integrityis suspi-
cions these days is Eastman Kodak In lune the film
manufacturer announced a stock buyback, which is
often a sign of confidence. ln Kodaks case it looks
more like a sign of desperation. The plan author-
ized Kodak to repurchase up to $l billion of
stock, with $581 million of the money coming
from a ref und of taxes it paid in the 19905.
lf carried through, the buyback will shrink Kodak's shares
outstanding by 25% and thus lift EPS-but not add a penny in
earnings. Quite apart from the Synthetic flavor to the EPS gains
. ' is the matter of timing: Shares that Kodak bought back last
year are now worth less than half of' what it paid.
, ' l 'G Another red flag: As Kodak burned through more than a
third of its cash in 2008. it lifted the rate of return it assumes
its pension fund will earn from 86% to 9%, thereby lowering
Callaway and Nu Skin: profit: through sales. not gimmicks.
JANUARY 12, 2009 r= o n s E s 49
Companies with high earnings quality and below-market multiples are prime targets for value investors. Stay away from enterprises
that are expensive and rated as having suspect earnings quality by financial sleuth Audit Integrity. One such firm: Atlas America;
MARKET 2008 EST
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COMWENTAL RESpURCEiSWi* 3.4 i 9
KORNIFERRY INTERNAHONAL 0.i5i i i 11
i MANvoweii i g 2.6 7
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i KODAK 1.3 44
min GRiOUP T7 27
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Novéititéf 1.5ii ii is
i APPWLIEVD MAiriiEiuALisi 15? 40
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ARTHUR J. GALtAGHea s. CE 2.3 16
exrness scmns 14.6 19
i Aruisgmsmcn NA
'Accounting and governance risk; 100 is best. 'Sellin
Fundamental; via FactSet Research Systems.
the amount it has to set aside. (A year earlier
General Motors did the opposite, reducing its
assumed rate of return from 9% to 85%. )
Unless Kodak proves to be an unusually
savvy money manager, its pension funding
needs tomorrow will be increased by its
Insider selling, other than that taking
place as part of scheduled diversification
plans, is something else that Al watches. lt is
not pleased by what is going on at natural gas
company Atlas' America.
On Sept. 9 Chief Executive Edward E. Cohen signed off on
Atlas' plan to use $50 million to repurchase its own shares. The
company quickly used $14,9 million from the buyback allocation,
plus $20 million from a previous one, to acquire Atlas stock at
$34.76 per share. The same day Cohen signed off on the repurcl-iase,
the stock was trading between $31 and $34 and he transferred
53.2 million of his own shares to a charitable trust headquartered in
his Philadelphia home.
50 F o n n E s JANUARY 112009
stumped analysts stopped following the company, yet it still trades at a rich 28 times trailing earnings.
, EFORF , SEMÆELTS m, ”
88 Cut ratio of other operating expenses to total expenses
Å Cut ratioof CEO-toCFO compensation
86 ratio of goodwill to totaliaisisets i i
i ig; Ciæäof goodwill to total assets T
85 ; ut ratio of intanigiiibleias; s to total assets i
84 i Separation of chairman and CEO re:
:T Cut raitiio of intangible assets to total asfsrets A
83i i Low ratio of pension obiliigations to Iiabilities ii
81 iM-Cuitiratio oi aicciounts receivable to salesiii
80i ii ilow ratioiofi acgcciáuhgireceivable to sales , i
14 Upped pension retum assumptionii
17 Unusual jump in operating margin
18 Upped ratiio of woÆin-pirogressi to inventory ii*
20 Cut ratio of doubtluiliaicicounts allowance toireceivables i
E iiLow ratio of SG&A1 to operating expenses T ii ii , ii
34 i Upped ratio of initangiblferassets to total assets
34 *Elpped ratio of iTScD to operating expenses
i3S Unusual jump in operating margin i-i
F low ratio of SG&A1 to operating expenses
i 37 Qpâdgatio of deferreditaxes tt) operating expenseisi
g. general and administrative expenses. NA: Not available. Sources: Audit Integrity; Reuters
IK-rrays 7-1? i *
any signs om"
By Oct. 10 Atlas' stock had fallen by half
to $16.07. lt then tumbled another S5 in
November after a Citigroup analyst warned
clients that an Atlas pipeline subsidiary was at
risk of violating its debt covenants if oil prices
stayed below $60 per barrel over an extended
period of time.
If that wasn't reason enough to stay away
from Atlas, Audit Lntegrity points to mount-
ing deferred income taxes as a potential hit to
cash flow from operations (net proñts plus
depreciation and other noncash charges) as
; iccelerated depreciation and investment tax credits wear off.
Another strike against Atlas: Cohen and Matthew A. Jones. Atlas'
Chief financial officer, received more than ten times their salaries
from stock-based incentives last year. The norm is more like two
times, AI says. The elevated ratio "may indicate that company
executives have incentives [to favor] short-term profits and stock
gains over the longer-term health of the company, " Audit
Integrity cautions. F