This news item, dated February 26, 2007, caught my eye:
“AES announced Monday that it plans to reschedule the release of its fourth-quarter and full-year results because of errors in its financial statements. AES had similar problems last year, when the company admitted material weaknesses in its accounting systems, particularly in its foreign operations. The company expects, as before, to restate its financial results. The company also announced that may have a stock-option dating issue.”
In rating a company’s quality–the very first step in deciding whether it is even a candidate for your investment dollars–management trustworthiness is a mandatory litmus test.
The Sensible Stock investor seeks unquestionable integrity of management. Here are examples of situations that should stick a big red flag on any company:
• Companies being sued on antitrust grounds.
• Companies that produce unsafe or harmful products and attempt to deny or evade responsibility.
• Companies that admit lying or misleading the investing public in any way.
• Companies whose reported financials are questioned, or which have a reputation for “aggressive accounting.”
AES falls into the last category. First, it can’t seem to get a handle on its own numbers. For two years in a row, it has had to delay or restate its financial results. In my book, that makes them “untrustworthy.” I don’t mean this in a personal way. They may all be good, honest guys there at AES. They may simply be incompetent. Their intent (whether to be honest or misleading) is not the issue. The real issue is, can you trust their numbers? Clearly you cannot.
If I were evaluating this company for possible investment, I’d save myself some time and toss it out as soon as I ran across this news item.
Note also that AES has a potential second problem: It may have a stock option back-dating issue. The admission of these issues–which are sometimes innocent but are often outright fraud–has become almost epidemic over the last year or so. Because the practice was so widespread, perhaps it shouldn’t be considered a trustworthiness issue.
But then again, not every company that issues stock options backdated them. Backdating options, after all, moves money out of shareholders’ pockets and into the pockets of management or board members. It is lying to shareholders. If management lies about that, what other subjects might they be misleading you on? New products? New markets? Operational improvements? How can you know?
With what kind of company would you rather place your bet? A company which effectively cheats its owners out of some of the profits to which they are entitled, or one that doesn’t, keeping its owners’ interests foremost. The question answers itself.
Some indicia of untrustworthiness are easily seen in public records. Has the company had a formal SEC investigation in the past year or two? Has it repeatedly taken “one-time” charges year in and year out? Has it recently restated earnings? Has its CEO or CFO resigned under questionable circumstances?