Let's not fool ourselves that we have all the facts -- we can never be sure that a company is what it says it is.
An accountant and an engineer, both thirsty, are standing at one end of a room -- a keg of beer sits opposite them at the other end. Every ten seconds, they're allowed to move half the distance from their existing position to the keg.
"This is great", says the engineer, rubbing his hands.
"What are you talking about", replies the accountant. "You know we're never going to actually reach the keg".
"I know that", says the engineer, "but in a few minutes I'll be close enough for practical purposes".
Maybe it's the engineer in me, but this is how I feel about analysing companies. We can get tied up in the details of ratios and forecasts, and miss the bigger picture.
In particular, there are some caveats we need to bear in mind when looking at accounts:
- The balance sheet is just a snap-shot of the company at a point in time. That point is usually two to eight months in the past, and a lot can happen in a few of months. Management often arrange for key measures, such as stock levels and debtors, to look their best at the year-end;
- Accounting is as much an art as a science. Whether presenting a "true and fair view" of the company (as required by the Companies Act), or a "fair presentation" of the company (IAS/IFRS definition), the directors and accountants have considerable discretion in preparing their figures;
- Remember too that the basic data from which the accounts are prepared may, by its nature, be inaccurate. Is the stock in the warehouse really correct? And who knows how much oil is really in an oilfield?
There's a saying that "profit is opinion, but cash is fact". While I agree that cash is much less susceptible to manipulation than profit, even that figure is not always set in stone. An extreme example, admittedly, but investors in Crown Corporation / Langbar may have some opinions on this subject.
When we consider the variance that exists in historical data, it is not surprising that forecast information is even less reliable. If a company announces EPS growth of 18%, or 22%, when the market had expected 20%, I don't see that it makes a lot of difference. It may have a short-term affect on the share price, so I cannot ignore that, but it's unlikely to change my assessment of the company.
I'm not advocating sloppiness in place of diligence when doing research, but I think we have to get the balance right. We need to have an understanding of the business and its valuation, but let's not waste time on spurious accuracy. Get close enough for practical purposes.
