Earnings Quality

Here’s an article I read in MyPaper January 11, 2010 in Singapore. It is titled ‘Why all earnings are not equal’—an interview with Robert Olstein (Olstein All-Cap Value Fund) by Gretchen Morgenson for New York Times (I suppose NYT means that =P ).

And I find this a coincidence. I was recently speaking with Jackson, an friend of my sister. And he was talking to me about investments (more like me picking his brain). One of the things he mentioned is earnings quality.

Earnings (and profits) is just a number. It can be manipulated, defined, reviewed, re-defined, rounded off, obscured, obsfucated, etc. The information and the source of this earnings define its quality.

One of the most common example:
You take a look at the earnings of a company, and you see that this year there’s quite a sharp increase in earnings. This would look out of place when compared to previous years. So, you read the annual report/news in more detail and found that the company has just sold an asset (a building, land, factory, its operations, a subsidiary, etc). This means that this year’s earnings does not reflect the true business earnings. This is nothing bad. The analyst just needs to be aware.

Another type of obsfucation is the EBITDA. EBITDA = earnings before interest, tax, depreciation & amortization. Amortization = depreciation of non-tangible assets. I think it is bullcrap. All I know is that it does not reflect the actual earnings (or profit) of the company, and it’s useless except for obsfucation. Apparently, it is used by tech companies because they typically have very high cost of operation. And EBITDA is used to give a positive effect. Pffft…

The 2 scenarios below are sneakier. But can be easily spotted by checking the disparities between its earnings and its excess cash flow.

1. from Vincent (wshiong.blogspot.com)
The articles mentioned that this disparity can show up in the ways companies account for capital expenditures. Certain assets in a company can depreciate over the years. To increase the earnings (& profits), a company can manipulate the amount of depreciation. For example: KNM listed in Bursa Malaysia. Apparently, in order to plump up its earnings, it changed the depreciation of its assets from 99 years to 999 years. This would reduce the annual depreciation, and thus increase the earnings.
I told you these guys are sneaky. The article says: “One way to assess the accuracy of management’s estimates is to compare, over time, how much a company spends on new plant and equipment and how much it deducts in depreciation each year.”

2. from Jackson
A company (lets call it Company A) can also sign an agreement with another company (Company B). The agreement says that Company B agrees to buy 100k of products from Company A. Since this is considered a business done, it is listed in the earnings report as receivables. However, this deal is done near the end of the financial of Company A. And once the financial year is over and annual report done, they will terminate the agreement.
However, this ‘transaction’ will show up in the cash flow as a discrepancy because the amount received does not match the earnings. I mean, seriously, Company B wouldn’t be that crazy to actually give Company A money for a fake show.

For conclusion,
I’m gonna quote the article:
Some of the discrepancies that emerge can be temporary, cased by the lag time between an initial investment and subsequent write-downs for depreciation.

Companies in a growth phase, for instance, will show greater capital expenditures than depreciation as they increase investments in plant and equipment.

Consistent gulfs between capital spending and depreciation should concern investors. “You have to reconcile the differences, or the market will do it for you.”

Nice shiny gold

I opened a Gold Investment Account (GIA) with Public Bank on Monday 6 Oct 2008. 20 grams of gold at the price of 95.20 Ringgit per gram. Today it’s 100.79 Ringgit/gram. Maybe I should deposit another 10-20 grams seeing that it’s on a bullish trend. Clickety click for PBB’s gold price.

Of course, there are other ways of trading gold, such trading futures in COMEX, trading in spot gold in London, buying physical gold or buying gold coins (e.g. Canadian Gold Maple Leaf, Krugerrand, US Gold Eagle Coin, Chinese Panda, etc…)

What prompted me to invest in gold is that I read around the net and those-in-the-know advised to put money in gold during this time of crisis.

I read around and the reason is that people will flock to gold when there is inflation, stock market crisis, bank failures and political instability (war).

[From this point onwards, it’s purely me typing out based on my limited understanding of economics and trading. So, caveat emptor — let the buyer investor/reader beware.]

1) US had just printed tonnes of money to finance the bailout. Printing more money will cause inflation. 2) Next the stock market is in terrible state. Especially bad at this time of writing. So people flock to safer investment vehicles. 3) And there are lots of bank failures in the US and everywhere else right now. In fact, Iceland just went bankrupt. But then I’m investing indirectly through a bank, janganlah PBB goes belly up.

Another thing I found out was that central banks sometimes manipulate the gold futures price, to limit the price. The reason is not to make gold shine too much compared to the cacated stock market (pun intended). If gold performs too well, then no one will want to invest in the stock market. Consequently, the doomed financial houses will not be able to get new capital from the stock market.

However, the price of physical gold is still pretty high, as evident from the price of gold coins that had not dropped much. Suggesting that the demand for gold is still pretty strong, and further implicating that gold price is being manipulated.

“So?!” you asked.
So, this is an opportunity to buy when gold price is manipulated down. Central banks don’t really care much for gold price. They are just trying to save their banking system. So once habis manipulating, they cabut lah… and gold will continue to move as usual… which I hope is up. Well, at least ‘up’ is what many people are saying lah.

the GOldDigger/
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A few references (do take note of the date the articles are posted):

1. 8 thing everyone should know about gold — James Turk in goldprice.org
2. Crude oil vs gold — www.bhcinvestment.com
3. Quick update by BHC Investment about gold
4. Gold price manipulation by central banks — www.bhcinvestment.com
5. Gold rush 21 – Video about gold price manipulation — www.bhcinvestment.com
6. Keep Your Eyes on the Horizon, the Long Term — goldprice.org
7. This period of suppressed prices is a gift, an opportunity, to load up — goldprice.org

KLCI in vomit blood

Small talk…
My posting of Martin Niemöller’s When They Came proved to be prophetic. =)
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As expected, KLCI lost slightly less than 1 pint of blood (out of 8. I got my own cacat calculations lah). Serious enough to be admitted. But far from dying. And as of today, it lost another 1 and a half pint more blood.

Lots of ‘experts’ in various internet forums are now saying the the full effect of the sub-prime crisis is being felt now… you know lah, the Americans and their complicated financial systems and creative financing and labyrinthine derivatives… sh!t like this is simply waiting to happen.
If it’s complicated, confusing and in Greek, sh!t will happen. If I can’t understand it, it’s not worth it.

Malaysian’s situation is made worse by the stupiak political scene. We’ve been on autopilot since the day Pak Lah became da man. I’m not sure where our country is headed. I can’t feel the vibrance of development in the air.

The KLCI apparently have been dropping just a wee bit faster than expected. So lots of people have been flip-flopping their position of when best to enter the market. The parameters change, the strategy have to change to adapt to it.

I’m beginning to wonder… if all these have less to do with how low KLCI will drop, and more to do with time factor. It just takes time to correct itself and recover. It certainly takes time for our political brouhaha to play out and make a mess out of itself.

So it’s back to more waiting as the economy and stock market searches for a direction. Maybe I should start looking into investing in the US.

In the mean time, the best bet now is to put your money in mutual funds ( <– S. Dali suggest using EPF to invest, a smart suggestion which I didn’t think off). Do a standing instruction with the bank to do monthly investments. Use this consistent investment to average out the crazy market movement (which has no direction <–this is worse than crazy). I know this is a blatant self-promotion… I’m a Public Mutual agent after all =P . But trust me, this is a rare opportunity… it’ll turn out to be gold in the future (well, unless Public Mutual gulung tikar).

the INvestor/

KLCI naik 30 points

WTF?! This is crazy. Like a freak of nature.
Is this a bull trap, or is this for real?

I can’t believe it. By noon, it was already up 20+ points. At the end of the day, dah naik 30+ points. I had expected the market to react positively toward Budget 2009, especially so after so much negativity for quite some time. Tak sangka naik so much in anticipation of a so-so budget. Seriously, our bourse is so ‘Malaysia Boleh’. I guess people expect Pak Lah to give out lots of goodies to ampu the rakyat.

Let me hazard a prediction…
KLCI will hold around the same level on Tuesday with lots of profit taking. On Wednesday, drop around 10 points. After that, market behaves as usual.

I bought YTLPOWR-WB at 0.470. Seeing that it naik to 0.525… a bit tak boleh tahan. So I put in my order to sell at 0.555. I d@mn greedy wei. Highest it went was 0.540. If I can sell for 0.555, then can makan Dragon-i, aye? Let’s hope I get to sell it at my greedy price on Tuesday. Then hope it jatuh gila-gila so that I can bottom fish. Nyek nyek nyek!