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3 The decline of US equity
markets By Julian Delasantellis
At his sentencing for the long series of
violent felonies that had terrorized his poor
neighborhood for years, counsel for the vicious
urban drug kingpin stood up and pleaded his
client's case before the judge.
"Your
Honor, I have here testimonies from all the local
merchants of loud and ostentatious heavy gold
jewelry, detailing how my client's patronage has
made their lives infinitely more fulfilling and
richer. The same from Rocco's
Car Painting Service, testifying that, without my
client's benefaction, his business specializing in
painting glossy black tigers on stretch pink
Cadillacs would have failed long ago.
"And, Your Honor, let us never forget my
client's generous contribution to the education of
our local medical professionals. Thanks to my
client's continuing deep involvement with his
community, the local doctors and nurses at City
Hospital's emergency room have gained a priceless
education in the treatment of bullet wounds, knife
slashes, and all manner of cases involving the
acute cocaine intoxication of teenagers."
If you think no one would ever be so
brazen in defending crime and criminals, you
haven't been following what Wall Street is trying
to get away with.
A big mistake that many
novice stock investors make when they are trying
to find stocks whose prices will go up is to
concentrate too much intellectual focus on the
stock price. For instance, this line of reasoning
has the investor looking at, say, two stocks, one
with a share price of US$20, another going for
$100. He figures, "Hey, I can get five times as
many shares with the cheap stock as I can with the
expensive stock; the cheap stock is a better buy."
No, it's not. There is a big difference
between what a stock costs and what it's worth.
For that, you have to introduce into the equation
the concept of profit, what the stock market calls
"earnings".
Aside from those degenerate
gamblers who, if they weren't watching business
cable channel CNBC, would probably be watching the
horse-racing channel, a company's profits, its
earnings, are the reason investors play the stock
market. Owning a stock gives you a share of the
company, so, by definition, it gives you a right
to a share of the profits. Therefore, experienced
stock investors look not at the stock price in
isolation, but in conjunction with the earnings,
specifically through an analytical tool called the
price/earnings (P/E) ratio.
A P/E ratio is
constructed very simply, but it is a key tool in
judging which stocks merit investment. Take the
stock's price, divide it by what the company
reports as its earnings per share (that's the
company's total earnings divided by the total
number of shares outstanding). Thus, a $20 stock
with $2 of earnings per share has a P/E of 10,
meaning, in essence, that when you buy the stock
you are paying $10 for every dollar of current
earnings.
A $100 stock with $20 of
earnings per share has a P/E of 5, so in essence,
even though this stock has a face value five times
that of the $20 stock, you are only paying half
for each dollar of earnings than the buyer of the
$20 stock. Here the more expensive stock is, in
actuality, the cheaper one.
Of course,
constructing valid P/E numbers depends on
continuous and dependable access to both stock and
earnings data. Getting up-to-date stock data is
easy; hundreds of websites carry near real-time
stock-price data, and it is not at all unusual for
even small local-newspaper websites to have "enter
quote" boxes on their pages next to the filler
pieces on next week's schedule of the Ladies'
Auxiliary Rhododendron Club. Getting the "E" data
of a P/E calculation, that's another story.
Earnings data are not nearly as readily
available, or, in financial lingo, not as
"transparent" as are stock prices. For one thing,
they are not updated and released on a
minute-by-minute basis through the trading day. At
the most, companies only release them five times a
year. More important, in contrast to stock-price
data, which are gathered and released to the media
though the stock exchanges, earnings data are
released only by the companies themselves. Any P/E
quote is only as good as the integrity of the
company that has released and, it is hoped, stands
by the data.
Until recently, that wasn't
thought to be that much of a problem. After all,
for a corporate executive knowingly to release
false corporate earnings data represents the
prosecutable offense of criminal fraud. Wouldn't
the threat of doing hard time, acting to buttress
and fortify the American corporate chief executive
officer's innate probity and integrity, ensure
accurate earnings data released to investors?
Not in 2002 it didn't. If the ancient
Greek philosopher Diogenes, the one who searched
the streets of Athens with an oil lamp looking for
an honest man, had been reincarnated and arrived
on Wall Street in 2002, one would hope he had both
a very sturdy pair of walking shoes and a lot of
lamp oil. That was the year that company after
company had to announce that they were "restating"
(ie, being forced to tell the truth after being
caught lying through their teeth) their earnings
downward.
The two biggest poster boys that
year for US corporate prevarication and mendacity
were the multibillion-dollar bankruptcies of
WorldCom and Enron, but they were far from alone.
From AOL to Waste Management, that year US
corporate management admitted it had a very
serious substance-abuse problem, and the substance
that it was abusing most was the truth.
At
the time, conservative pundit and commentator Ann
Coulter attributed the blame for all this
corporate malfeasance on, guess who, US president
Bill Clinton. She argued that the generally
morally corrosive atmosphere engendered by his
promiscuous presidency had rendered corporate
executives powerless to resist the assault on
their ethical fortitude; they had no choice but to
lie. For those whose analytical faculties are
so putresced in the current toxic,
hyper-polemicized US political climate that they
accept this glabrous rationalization, one must
admire that, even with their brains so obsessed
and besotted with apparently never-ending thoughts
of furtive, fevered presidential gropings,
corporate America was still so able to come up
with so many novel and ingenious ways to tell
howling whoppers about their earnings.
There are two basic ways to boost
corporate earnings - either increase revenues or
decrease costs. If you can't do either honestly,
then you lie about it. "Creative accounting" is
the polite euphemism for these balance-sheet
prevarications; at times in 2002, it became very
creative indeed.
MCI/WorldCom shifted away
the current operating costs of connecting with
other telecommunications companies by putting them
in the capital-balance section of its ledgers,
thus allowing these current operating expenses to
be amortized into forward quarters far into the
future. As for the income side, the company
created and claimed billions of non-existent
assets as "corporate unallocated revenue
accounts". On June 25, 2002, it announced that its
past five quarters of earnings data had been
"overstated" by $75 billion.
At Qwest
Communication, not only did former CEO Joe Naccio
lie about the company's earnings, he also
qualified for admittance to
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