Editor's note: This column is part of a three-day series on Cendant, running April 14 through April 16. An overview details
Revisiting a year-old column is a useful exercise because it reveals how one's thoughts have changed. The discipline required to confront past assumptions is infrequently mustered amid the cyber-daytrading-last quarter's performance muck which now characterizes much of the investing world.
So I was prepared to feel regret when I looked back on my
column of April 16, 1998. But aside from my moronic bragging about not owning what is now
(12-month performance: +110%), I don't regret much at all. And there's some potentially good news to share.
The Era of Earnings Management
A year later, the base issue is that the "cult of reported EPS" still reigns in the investment marketplace. In the current
10,000 climate, large companies with enormous latitude to "manage" earnings to satisfy the idea of "consensus estimates" coexist in an unholy alliance with the investors and analysts whose careers and bonuses depend upon maintaining these valuations. As a result, management is pressed to contort their financial departments to produce the numbers to keep the stock moving.
Sometimes -- often -- the numbers are just not up to expectations.
To be fair, these machinations are not always as nefarious as they seem. The alleged fraud in the case of
is clearly an uncommon occurrence. Timing investments, expenditures, realized gains and whatever else exists in the accounting bowels of a multibillion dollar corporation is not necessarily bad business or misleading to investors. Managers and investors all yearn for the simplicity of an
Automatic Data Processing
that just churns it out at 15%-ish seemingly forever. A little tweaking here or there to make life a bit easier is generally OK.
But life is rarely that simple in an ultra competitive, capitalist system. Sometimes -- often -- the numbers are just not up to expectations. But the longer companies play games to delay the inevitable, the uglier the reaction. And once you get started on this road, the more tempting it is to stuff the retail pipeline on the last week of the quarter, or try to shove another $10 million of future expenses into an acquisition charge.
Reform in the Works
On a more positive note, Cendant-esque debacles have prompted a fairly serious attempt by
Financial Accounting Standards Board
, or FASB, to place sharp restrictions on the use of pooled accounting and flagrant one-time and upfront charges for acquisitions, if not to outlaw them completely. These credible efforts to establish some sort of a level playing field by which investors can make reasonably informed comparisons (if they chose to do so) between companies has been met by a hailstorm of criticism on both sides of the fence.
Naturally, many corporations, particularly those with very highly valued stock used liberally as acquisition dollars, are screaming that the restrictions will "hurt" reported earnings and thus their stock prices, rendering them helpless to make acquisitions they could not justify if they had to pay cash. A number of institutional investors have chimed in with a similar argument, presumably because if they really had to follow the 378 stocks in their portfolio without relying solely on a computer-generated printout of the last four quarters of reported earnings, life would be unfairly complicated.
I'm uncomfortable with a company that thinks its shareholders are too lazy or stupid to look any further than the earnings line in The Wall Street Journal.
I am personally uncomfortable with a company that thinks its shareholders are too lazy or stupid to look any further than the earnings line in
The Wall Street Journal
. What I want to invest in is a management team that treats me like an adult, presents me with a fair and comprehensive look at their financial position and updates its shareholders on a regular basis with an honest assessment of the state of business.
Unfortunately, what Levitt's critics are suggesting -- that investors are not capable of looking through the effect of one-time charges and the difference between reported earnings and earnings with acquisition goodwill added back -- is essentially true in today's investing environment.
Even if the detractors prevail though, the reality is that companies that play loose with the numbers are eventually rewarded with a lower multiple because once-burned creates a very shy group of potential investors.
Cendant Today: Ripe for Contrarians
Which brings us to Cendant today. The company has repurchased a boatload of stock and continues to do so aggressively. It has spent a fortune rectifying past wrongs in the form of asset sales, earnings charges, expensive break-up fees for deals not done and millions for ongoing lawsuits. Not to mention an awful lot of PR backing and filling.
But after a hellish year, the base of a high-margin, excess-cash-flow-generating business model with reasonably predictable double-digit earnings and cash-flow growth is emerging. Yes, the overhanging lawsuits are ugly and will be a material dollar amount. But, in the mid-teens, is that already in the stock?
A bigger issue is the lingering distrust of management's presentation of the numbers, which will take years to go away. The seared memory of a stock that goes from 42 to 7 in your face and is associated over the media with the word "fraud" does not disappear from portfolio managers' psyches in a hurry.
I am sure that Cendant has taken on a
-like aura for many investment management firms, with the conclusion being "We've got to be able to find an 'easier' stock to buy than that." So until the shareholder lawsuits are settled and X number of clean quarters are produced of what Cendant management originally envisioned, it's tough to see the stock breaking out of a mid- to high-teens trading range. But if you have even one contrarian bone in your body, it's clearly worth a look.
Jeffrey Bronchick is chief investment officer of Reed Conner & Birdwell, a Los Angeles-based money management firm with about $1 billion of assets under management for institutions and taxable individuals. Bronchick also manages the RCB Small Cap Value fund. At time of publication, the fund was long Automatic Data Processing and Philip Morris, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bronchick appreciates your feedback at