The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [257]
3 In 2002, Qwest was one of 330 publicly-traded companies to restate past financial statements, an all-time record, according to Huron Consulting Group. All information on Qwest is taken from its financial filings with the U.S. Securities and Exchange Commission (annual report, Form 8K, and Form 10-K) found in the EDGAR database at www.sec.gov. No hindsight was required to detect the “change in accounting principle,” which Qwest fully disclosed at the time. How did Qwest’s shares do over this period? At year-end 2000, the stock had been at $41 per share, a total market value of $67.9 billion. By early 2003, Qwest was around $4, valuing the entire company at less than $7 billion—a 90% loss. The drop in share price is not the only cost associated with bogus earnings; a recent study found that a sample of 27 firms accused of accounting fraud by the SEC had overpaid $320 million in Federal income tax. Although much of that money will eventually be refunded by the IRS, most shareholders are unlikely to stick around to benefit from the refunds. (See Merle Erickson, Michelle Hanlon, and Edward Maydew, “How Much Will Firms Pay for Earnings that Do Not Exist?” at http:// papers.ssrn.com.)
4 Global Crossing formerly treated much of its construction costs as an expense to be charged against the revenue generated from the sale or lease of usage rights on its network. Customers generally paid for their rights up front, although some could pay in installments over periods of up to four years. But Global Crossing did not book most of the revenues up front, instead deferring them over the lifetime of the lease. Now, however, because the networks had an estimated usable life of up to 25 years, Global Crossing began treating them as depreciable, long-lived capital assets. While this treatment conforms with Generally Accepted Accounting Principles, it is unclear why Global Crossing did not use it before October 1, 1999, or what exactly prompted the change. As of March 2001, Global Crossing had a total stock valuation of $12.6 billion; the company filed for bankruptcy on January 28, 2002, rendering its common stock essentially worthless.
5 I am grateful to Howard Schilit and Mark Hamel of the Center for Financial Research and Analysis for providing this example.
6 Returns are approximated by dividing the total net value of plan assets at the beginning of the year by “actual return on plan assets.”
7 Do not be put off by the stupefyingly boring verbiage of accounting footnotes. They are designed expressly to deter normal people from actually reading them—which is why you must persevere. A footnote to the 1996 annual report of Informix Corp., for instance, disclosed that “The Company generally recognizes license revenue from sales of software licenses upon delivery of the software product to a customer. However, for certain computer hardware manufacturers and end-user licensees with amounts payable within twelve months, the Company will recognize revenue at the time the customer makes a contractual commitment for a minimum nonrefundable license fee, if such computer hardware manufacturers and end-user licensees meet certain criteria established by the Company.” In plain English, Informix was saying that it would credit itself for revenues on products even if they had not yet been resold to “end-users” (the actual customers for Informix’s software). Amid allegations by the U.S. Securities and Exchange Commission that Informix had committed accounting fraud, the company later restated its revenues, wiping away $244 million in such “sales.” This case is a keen reminder of the importance of reading the fine print with a skeptical eye. I am indebted to Martin Fridson for suggesting this example.
8 Martin Fridson and Fernando Alvarez, Financial Statement Analysis: A Practitioner’s Guide (John Wiley