Old Firms' Accounting Sins Will Haunt Young

Editor's Note: Jim Cramer's column runs exclusively on RealMoney.com; this is a special free look at his column. For a free trial subscription to RealMoney.com, click here. This article was published May 16, 2002 on RealMoney.

You can't fake revenue growth. At least that's what we thought. When I analyzed companies at the hedge fund and when I look at them now, I always start with revenue. I start with revenue because, as we all came to know, there are so many ways to fudge earnings that I simply stopped caring that much about earnings growth. Or to put it another way, earnings, and companies' abilities to massage those earnings, always made me skeptical about the real underlying growth.

So we relied on revenue. Now it looks like that, too, was a mistaken approach, because companies made up false revenue all of the time and they either won't be flagged by accountants or were well-hidden by financial officers and salespeople.

The revenue recognition problems we have seen at L90(LNTYE Quote), a once-hot dot-com concern, CMS Energy(CMS Quote), Reliant(REI Quote) and, of course, Enron, remind us again that investing has become more difficult, more problematic, in equities because of the lack of enforcement against bad actors at the corporate level.

Let's hope that renewed scrutiny, the kind that we are getting in spades now from the perhaps too-maligned Securities and Exchange Commission, changes that. Until then, investors will have to fall back on other benchmarks of corporate valuation: the quality and demeanor of its executives and the integrity of well-established companies with long histories of steady growth from real operations that we can touch and feel and perhaps eat, smoke and drink.

And all the innovative newer companies, the ones we measured with revenue growth will now have to suffer the consequences of having no track record in ethics to scrutinize. In other words, capital formation for new growth companies is going to take a real beating until these government probes run their course.

Random musings: The CMS investigation is just so horrible. These guys didn't need to do what they're accused of; they were solid managers doing a good job. But they might have gotten the bug, I guess, and couldn't resist the "congratulations, gentlemen" and the higher stock prices that come from beating the numbers. ... This Edison Schools(EDSN Quote), a danger zone pick on my radio show, really is collapsing. I wouldn't bet with these guys. ... Don't forget, all this week I am giving out an autographed copy of my new book, Confessions of a Street Addict, to listeners whose questions I read during the "fixing your 401(k)" section of my radio show. Just email your questions to me at [e-mail], and you could get it answered on the air. Or, if you can't wait, click here to order your own copy now.