Beware Investing By Numbers

Foreword from ShareInvestor

This article “Beware Investing By Numbers” by Goh Eng Yeow was first published in The Straits Times on 20 Mar 2011 and is reproduced in this blog in its entirety.

Look beyond the financial figures when trying to suss out whether a company is doing well

Many investors and analysts have an almost inane obsession with financial numbers when it comes to analysing the performance of a company.

Turn up for the results meeting hosted by a listed company and you will find analysts spending an extraordinary amount of time quizzing the management on each number produced in the company’s accounts.

Now, trying to squeeze management for more details on the numbers is fine. After all, financial numbers are still the most reliable gauge which an investor can count on to find out how a company is doing.

But the accounting irregularities which surfaced in a number of listed firms in recent years suggest that numbers can be manipulated.

Worse, such anomalies can escape even the sharp eye of the most diligent analyst for years. And when the misfeasance finally comes to light, it is usually too late for investors to make their escape.

So, what is an investor to do in order to make his investment decisions wisely?

The first thing to note is that there will usually be some tell-tale signs to suggest that all may not be well at a company, even though the financial numbers furnished by it reflect otherwise.

In fact, some of the safeguards which an investor can take to protect his investments have been highlighted by popular television dramas.

Take the Hong Kong serial Growing Through Life, now showing on cable.

In one episode, veteran actor Damian Lau, who plays a successful business tycoon, tells a cocky young marketing manager, played by Hong Kong heart-throb Bosco Wong, to go through a list of the company’s customers to check if they are financially sound.

But despite his best efforts, Wong cannot find anything wrong with the customers’ financial numbers, until Lau tells him to check around the customers’ business partners as well.

“Now, if your partner is in serious financial difficulties, won’t that affect you as well?” Wong was told.

In those few short minutes, Damian Lau drives home the importance of looking beyond financial numbers in assessing a company’s credit-worthiness and its value as an investment.

By all means, an investor should try to turn up at a company’s results briefings and its annual general meetings to discuss the numbers.

On such occasions, he should keep his eyes and ears open for any signs which may set the alarm bells ringing.

Two years ago, when accounting irregularities surfaced at a few S-chips – as China-based listed firms here are called – pointed questions were also being raised about the huge cash hoards purportedly held by other S-chips.

I was told that at one S-chip, the investment relationship officer brandished a bank statement during an analysts’ briefing to try to boost confidence that the cash was indeed in the bank.

Now, if you were merely looking at that company’s accounts at that point, you would get a beautiful set of numbers which showed that the firm was in the pink of health.

The amateurish action of the company’s executive, however, suggested that something might be amiss. It comes as no surprise to find that auditors later uncovered irregularities in that company’s cash balance.

Sometimes, it is the attitude displayed by management during the discussion which turns out to be the give-away.

Many years ago, I interviewed the chairman of a listed company who displayed no interest in the business he was running at all, much to my surprise. Instead, he spent much of the interview peppering me with questions on how to attract interest in his stock.

His company became another casualty in the shakeout triggered by the global financial crisis.

But there are many happy encounters worth recounting.

During the bird flu scare six years ago, I turned up for the annual general meeting of Cerebos Pacific – the maker of the well-known tonic, Brand’s Essence of Chicken.

Its share price had been badly affected by bird flu fears, but its top management – led by chief executive Eiji Koike – took pains during the meeting to explain to investors that the company’s suppliers took extraordinary measures to keep their poultry out of harm’s way.

Their honesty and patience paid off, with Cerebos doubling in share price during the ensuing period.

Sometimes, you will find that simply by striking up a conversation with the company’s management, you can assess the level of comfort you are likely to enjoy should you park your money with it.

A few years ago, I interviewed the boss of Hongguo International, a China-based footwear maker which was listed on the Singapore Exchange until last year.

The interview was turning into one of those dry run-of-the-mill stories about the company’s expansion plans when our discussion turned to the subject of how young Chinese women chose their shoes.

He spent the next 30 minutes talking about shoe fashion in China, and it was clear from the way he spoke that he was very passionate about the business.

Now, even a novice investor knows that as China becomes more prosperous, there will be a huge demand for shoes – especially from young women who will buy several pairs at a time just to keep up with the changing seasons.

Too bad, the company was taken private by the management in the aftermath of the global financial crisis as its share price slumped.

But then again, if you had studied only the company’s financial numbers, you would have gathered only that it was a thriving shoe business.

Talk to its bosses, and chances are that you would feel the same passion as they did as they pursued their dream of fitting the feet of every girl in China with their shoes.