Wednesday, May 12, 2010

Candor Counts

When reading through the press releases that most companies issue to announce their quarterly financial results, one can get a pretty good idea of which companies are pleased with their earnings and which are not. Unfortunately, however, it often requires reading between, or in this case below, the lines.

When the earnings are positive, the company will usually lead with a statement listing its net income and describing how strong it is. When the earnings are negative, a whole slew of issues are likely to be discussed before the earnings number is deemed relevant.

Consider Nu Horizons (NUHC), a company we have previously discussed as a potential value investment. Two years ago, when earnings were positive, the company reported net income in the 3rd sentence of the press release, in a candid and matter-of-fact manner:

"Net income for the quarter was $1,155,000"

Fast forward to last week's results where the negative earnings number is not reported until the 7th paragraph, getting trumped by such items as sequential sales results, supplier updates, an update with respect to the strategy for Asia (this is a company based in NY), workforce reductions subsequent to the quarter end, a statement amount debt reduction expectations, sales by geographic region, and a discussion of the company's tax assets!

Managers of public corporations are just as human as the rest of us: nobody likes giving bad news. When management is not candid with its shareholders, however, it leaves a poor impression with investors. Here are Warren Buffett's comments on candor:

"We will be candid in our reporting to you, emphasizing the pluses and minuses important in appraising business value. Our guideline is to tell you the business facts that we would want to know if our positions were reversed. We owe you no less. Moreover, as a company with a major communications business, it would be inexcusable for us to apply lesser standards of accuracy, balance and incisiveness when reporting on ourselves than we would expect our news people to apply when reporting on others. We also believe candor benefits us as managers: The CEO who misleads others in public may eventually mislead himself in private."

This topic may be similar to one we've previously seen where managers blame externalities for negative surprises, and credit themselves when positive surprises occur.

Disclosure: Author has a long position in shares of NUHC


Anonymous said...

Hey Saj, I know its not related to this post, but I was wondering, what is Warren Buffet like? I liked how he is honest, open, and personal in his shareholders letters. However, some of his actions also seems hypocritical. In his earlier letters, he bashes I-bankers and derivatives, this year he supports Goldman Sachs and says they did no wrong, as well as take a HUGE derivative position. I don't see how a person who hated derivatives, and loved to play it safe has 63 billion dollar derivative portfolio. Is he losing his roots?

Saj Karsan said...

Hi Anon,

Unfortunately I can't claim to know him personally, so I can't answer your first question. But for the second question, I would suggest that there's a difference between how a product is often used and how it should be used. So while derivatives can be employed in a dangerous fashion, they can also be quite useful; at least, that's what I have taken away from Buffett's discourse on the subject.