Can we really believe what companies tell us? Maybe! But there are ways and means of reading between the lines to decipher the truth.
What is the true meaning of announcements to the stock market? The underlying meanings of statements are often unclear, particularly to those investors still relatively damp behind the ears. You'll hear a lot about reading between the lines of 'directorspeak' to attempt to decipher true meanings and a board's intentions. But it's not always easy, particularly given the spin put on announcements by the company's financial PR consultants.
You know the type of thing, where a company says "despite challenging market conditions we have achieved strong turnover growth and are EBITDA positive," actually means "we are continuing to lose money and may well be asking you for a bit more quite soon"!?
When is good news bad news?
Often, people new to investing are surprised that a share price falls on what appears to be excellent news. Of course, this is usually because even better news was expected -- but it can also happen when cynical investors smell a rat. And who can blame them? Stock market history is littered with companies which made very positive-sounding noises shortly before their demise.
But let's be honest, a company may be owned by its shareholders but it is rarely run entirely in their interests -- unless the directors have decent stakes. And who seems the most likely to rise to the top of the greasy corporate pole; a committed and talented professional acting in the best interest of shareholders, or someone who really, really wants to get there? Let's be a tad cynical and agree (purely as a hypothesis you understand!) that it may just be the latter. And if that is the case, would you say such a person would be straight-talking, honest and caring if that course of action looked likely to damage his/her career prospects? Thank goodness we can still trust the financial probity of our MPs, but as for directorspeak, let's agree to be a little cynical.
A few examples
So to prove the point, here are a few real examples from recent history:
In December 2007, Royal Bank of Scotland (LSE: RBS) said: "RBS (excluding ABN AMRO) operating profit and earnings per share in 2007 [are] expected to be well ahead of market consensus". Sir Fred Goodwin, Group Chief Executive, said: "Although some of our businesses have been affected by the challenging market conditions, the Group's underlying earnings trajectory has remained comparatively unaffected".
RBS's share price rallied to 568p on the news. You know the rest. Just over a year later, Fred had gone, and the share price went lower than 11p as RBS reported a net loss of £24 billion for 2008. Some trajectory!
No-one's suggesting a direct untruth here -- but was RBS too determined to put a positive spin on things to preserve a few reputations? You be the judge.
Much smaller fry was Meldex (LSE: MDX). This jam-tomorrow specialty pharmaceutical and healthcare business was much-beloved by some private investors for its potentially exciting products. On 30 September last year, the chairman told the market: "…we have achieved significant growth in turnover and improved profits. With the newly revised management team and Executive Board, we feel that Meldex is well placed to capitalise on growth opportunities going forward".
Eleven weeks later, the shares were suspended and the company was "seeking to clarify its trading and working capital position".
Similarly, electric vehicle maker Tanfield (LSE: TAN) lost credibility when the boss's statement of 22 April last year: "We are already delivering on our strategy for 2008 and retain an extremely robust outlook for future performance" with the share price around 115p was followed just 10 weeks later with a profit warning that sent the shares under 6p.
These are just a few examples that sprang to mind from companies over the past couple of years. But it's easy to cherry-pick the losers. Also, trading conditions can and do deteriorate rapidly and the examples quoted aren't necessarily dishonest, so much as unduly optimistic.
What's the moral?
So what's the moral of this story? Maintain a healthy cynicism. Don't take things at face value. And concentrate on the figures more than the narrative of announcements. It's much harder to lie about figures. Yes, they can be massaged, but the numbers don't lie. And always make your own objective judgements about business prospects. Often, those closest to a company are some of the least objective people around.
As the old Russian proverb says, "a man is judged by his deeds, not by his words."
More from David Holding:
