Current Investment Perspectives

 

In less than two years, the investment climate has dramatically changed from irrational exuberance to irrational skepticism.  The mounting negatives impacting financial markets are staggering.  Investors miss “the good old days” when accountants were accountants.  Utility companies sold only electricity and natural gas; telephone companies were just phone companies.  The past ten to twelve years has clouded the financial peace of mind.  Retirement funds especially have been hurt in the past twenty- four months as questionable accounting practices, convoluted corporate business plans, and heavy debt loads are now dragging down corporate operations.

 

Business models operated for the past ten years under the assumption that stock prices would go higher and higher.  Access to capital went unscathed as corporations enjoyed declining interest rates and huge appetites for large quantities of their bonds.  Worldcom’s twelve billion dollar ($12,000,000,000) bond issue in spring, 2001 was one of the largest bond underwritings ever.  The company lowered its interest costs accumulated from acquisitions the company made over the past ten years.  Once lauded as brilliant and sophisticated, now Worldcom is facing downgrades by the rating agencies since several of the acquired ventures are facing liquidation and write-offs.

 

Enron is a whole other challenge unto itself.  Eighteen months ago Enron stock was held in every growth mutual fund in America.  Chairman Kenneth Lay appeared on financial shows, in newspapers and magazines as he took a sleepy utility company and turned it into an aggressive financial empire.  The stock traded at eighty five (85) times earnings and was the hottest stock going.  Very few investors ever stopped to question how a company with single digit growth rates could transform itself into one with double-digit growth rates in revenue and net income.  Its meteoric rise was credited to its highly paid employees, a short-term inventory shortage in energy supplies, and Wall Street’s appetite for large investment banking fees.  In many circles, Enron had achieved greatness similar to J.P. Morgan in the 1920’s and Drexel Burnham in the 1980’s.  The list of public utility companies that did business with Enron was staggering.  The company had become a full-service energy firm trading oil, natural gas, home heating oil, diesel, and in the end financial derivatives and other non-energy services.  As revelations continue to unfold, Arthur Andersen cannot take all the blame for the mess.  But if a senior partner at Arthur Andersen authorized fraud or the generation of fictitious financial reporting to hide or mislead investors, then Arthur Andersen may never recover from such a blunder.

 

Investors now must ask what other fraudulent events have taken place in the name of creativity?  The accounting industry is somewhat an oligopoly as five firms control 98% of the publicly traded corporations.  The evolution accounting firms underwent in the past twelve years is mind-boggling.  Investment banking relationships are prevalent as lucrative consulting fees often exceed audit fees.  Audit relationships are the loss leaders, which get the consulting partners in the door.  Fees generated from consulting seem to skew the financial reporting process.  Yet the partners at the major accounting firms continue to defend these practices.  The consequence is that annual reports no longer give investors objective information.  The holy grail of annual reports is the accountant’s letter that states unequivocally the report is generated in accordance to generally accepted accounting principles and is presented fairly.  The SEC has been lenient and unable to supervise the annual reporting process as accounting standards became obtuse through the years, and shielded highly leveraged companies from reporting all the facts on the balance sheets.  Qualifiers, footnotes, and accounting jargon fill the pages of these reports with little translation for the amateur investor who might trust management, the accountants, and the report to make favorable investment in those respective companies.

 

The Enron effect is now affecting other non-energy companies.  Large corporations that have enjoyed aggressive acquisition strategies now are being examined.  Tyco International is one of many which have used the cheap financing and hype by Wall Street to subsidize its strategy.  Tyco stock dropped 40% this week. 

 

Asbestos has hit over sixty companies in the past forty-five days.  Triggered by a large legal suit against Halliburton, companies including Viacom, Georgia Pacific, Dow Chemical and others have seen their market capitalization fall substantially as lawsuits are mounting.  Very few remember that asbestos was a government authorized material mandated to protect homeowners from the perils of fire.  The amazing material is fire retardant and has saved hundreds of thousands of lives through the years. Now it is the focal point of litigation.  Currently, affected companies trade at ten-year lows and offer excellent valuations in some cases.

 

Financial markets are efficient.  Companies cannot lie or mislead forever.  The market corrects things swiftly.  In the end, conservative investing remains the only way to safely and effectively manage assets.  Economic behavior is either rewarded or penalized once the truth is understood.  In less than twenty-four months a lifetime of events has taken place in the financial markets.  War, rumors of war, recession, accounting irregularities, and asbestos exposure/litigation have awakened investors to the fact that investment in common stocks can be somewhat risky.

 

Value investment management continues to reward the patient investor.  Growth models continue to de-accelerate.  Very few growth companies are experiencing growth. Therefore, investments should be disciplined.  Cash flow from operations is paramount in our investment decision.  Reported corporate earnings no longer give investors a good snapshot of the financial well being of companies.  Our investment research continues to generate companies with favorable prices to respective cash flows. 

 

Russell L. Robinson

5301 Virginia Way, Suite 150

Brentwood, Tennessee  37027

615.242.3447