Companies are hiding more from you than you realize…
Back in the late 90s, energy company Enron was a Wall Street darling. From 1998 to 2000, its stock surged 342%. It became America’s seventh biggest corporation…but the company was a farce.
Management used shady accounting to inflate its sales and profits. When the fraud came to light, Enron’s stock plummeted. In 2001, it filed for bankruptcy.
• In April, former Enron CEO Andy Fastow issued a serious warning…
Fastow was one of the main actors in the Enron scandal. He spent six years in jail for his crimes.
According to Fastow, many corporate executives are now doing what he did at Enron. He even accused tech giant Apple (AAPL) of misleading investors. Business Insider reported:
His point – an entirely correct one – is that the world’s largest company today is engaged in tax dodging behavior that, while perhaps technically legal, is clearly designed to increase profits and inflate the stock by misleading and confusing regulators (and perhaps investors) via a massively complex web of entities – exactly what he did at Enron! And this is 100% routine, common behavior among most large US companies.
Some people might find Fastow’s claim ridiculous. He is a convicted felon, after all. But Casey readers know better than to trust Corporate America.
• Regulators have accused Valeant (VRX) and SunEdison (SUNE) of similar crimes…
You’ve probably heard about the drug maker Valeant and the renewable energy company SunEdison. Their downfalls have been two of the year’s biggest investing stories.
Like Enron, both companies were hot investments. From January 2013 to July 2015, Valeant gained 332%. SunEdison’s stock surged 892% over the same period.
Like Enron, both companies used “creative accounting.” According to The Wall Street Journal, the Securities and Exchange Commission (SEC) is investigating whether “SunEdison misrepresented its cash position to investors as its stock collapsed.” Valeant is under investigation for its pricing and accounting practices.
And like Enron, both stocks have crashed. SunEdison plunged 99% before it announced plans to file bankruptcy. Valeant’s stock has plummeted 89%.
• The mainstream media paints Valeant and SunEdison as a couple “bad apples”…
According to most reports, it’s rare for public companies to pull tricks on investors.
But if you’ve been reading the Dispatch, you know that’s not true.
For the past few months, we’ve been telling you about the huge surge in share buybacks. A share buyback is when a company buys its own stock from shareholders.
Buybacks reduce the number of shares that trade on the market. This boosts a company’s earnings per share, which can lead to a higher stock price. But buybacks do not actually improve the business. They just make it look better “on paper.”
According to research firm FactSet, 76% of the companies in the S&P 500 bought back their own shares between November and January. Most companies used debt to pay for these buybacks. The Wall Street Journal reported last week:
The biggest 1,500 nonfinancial companies in the U.S. increased their net debt by $409 billion in the year to the end of March, according to Société Générale, using almost all—$388 billion—to buy their own shares, net of newly issued stock. Companies have become far and away the biggest customer for their own shares.
• Companies are also using “financial engineering” to make their businesses appear healthier…
Financial engineering is when companies use accounting tricks to goose their sales, profits, or cash on the balance sheet.
It’s how Enron, Valeant, and SunEdison hid problems from investors. Many other companies are doing similar things…
As you may know, U.S. corporations are required to report “GAAP” earnings per share. GAAP-based earnings comply with accepted accounting guidelines.
A growing number of companies are also reporting “adjusted” earnings that do not comply with GAAP.
Many companies use adjusted earnings to strip out “temporary” factors like the strong dollar or a warm winter. Management decides what to leave out and include when measuring adjusted earnings.
• Two-thirds of the companies in the Dow Jones Industrial Average report adjusted earnings…
In 2014, adjusted earnings were 12% better than GAAP earnings. Last year, they were 31% better.
Companies say adjusted earnings give a more complete picture of their business. But it’s becoming obvious that companies are using non-GAAP earnings to hide weaknesses.
As Dispatch readers know, the U.S. is in its weakest “recovery” since World War II. Europe, Japan, and China are all growing at their slowest pace in decades too.
With the economy so weak, many companies have had to “get creative” to grow earnings.
• Sales for companies in the S&P 500 have fallen four straight quarters…
Earnings are on track to decline a fourth straight quarter. That hasn’t happened since the 2008-2009 financial crisis.
These results would be even uglier if companies didn’t report adjusted earnings.
You see, it’s much easier for companies to mask weak sales or profits when the economy is growing. When the economy slows, those problems become too big to hide.
Right now, the global economy is clearly slowing. So expect to hear about more “Enrons” in the coming months.
• The stock market is a dangerous place to put your money right now…
If you're going to invest in stocks, keep three important things in mind…
You should avoid investing in businesses you don’t understand. Many hedge funds wish they had followed this advice with Valeant and SunEdison…
Despite these companies’ complex and unclear business models, some of the largest hedge funds in the world invested in them. This earned Valeant and SunEdison the nickname “hedge fund hotels.”
We also encourage you to avoid companies with a lot of debt. These firms will struggle to pay the bills as the economy worsens.
Finally, we recommend you steer clear of companies that need buybacks to increase earnings. Buybacks can give stocks a temporary boost, but they’re no way to grow a business. In short, money spent on buybacks is money not spent on new machinery, equipment, or anything else that can help a company grow. It’s especially a poor use of cash when stocks are expensive…like they are today.
• We encourage you to set aside cash and own physical gold…
A cash reserve will help you avoid big losses during the next big selloff. It will also put you in a position to buy world-class businesses for cheap after the “rotten apples” are exposed.
Physical gold is another proven way to defend your wealth. Gold has served as real money for centuries because it has a rare set of qualities: It’s durable, transportable, easily divisible, has intrinsic value, and is consistent across the world.
It’s also protected wealth through the worst financial crises in history. Investors buy it when they’re nervous about stocks or the economy.
This year, gold is up 22%. It’s at its highest level since January 2015.
For other proven strategies to protect your money from a stock market crash, watch this short video. In it, you’ll learn how to fully “crisis proof” your wealth. Click here to view this free presentation.
Chart of the Day
The U.S. stock market is wobbling on one leg…
Dispatch readers know buybacks have been a major driver of U.S. stocks. Since 2009, S&P 500 companies have shelled out more than $2 trillion on buybacks.
As noted, buybacks can make earnings look better “on paper.” They can also prop up share prices. With the economy slowing and earnings in decline, buybacks have been one of the things keeping stocks afloat…but even that’s starting to give way.
Today’s chart compares the performance of PowerShares Buyback Achievers Fund (PKW) this year versus the S&P 500. PKW tracks companies that bought back more than 5% of their shares over the past year. Holdings include McDonald's (MCD), Lowes (LOWE), and Macy’s (M).
From March 2009 to May 2015, PKW gained 314%. The S&P 500 rose 215% over the same period. Since then, PKW has fallen 10%. The S&P 500 is down 3%.
Investors appear to be losing confidence in companies that buy a lot of their own stock. That’s a big problem for the stock market, which is showing major signs of weakness.
Delray Beach, Florida
May 10, 2016
We want to hear from you.
If you have a question or comment, please send it to [email protected]. We read every email that comes in, and we'll publish comments, questions, and answers that we think other readers will find useful.