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To be fair the system that we have evolved seems to work fairly well. It really only goes badly wrong when the boss is not only vain, greedy and mendacious, but incompetent as well. Fortunately that seems to be relatively rare. Nevertheless, as investors our principal source of information about a company comes directly from that enterprise though annual reports and press releases. Only infrequently do we get data or evidence from outside sources that confirm or deny what the companies tell us.
I suppose the theme for this article has been generated by two recent events. One is the disposal by BMW of the Rover business and the second is the IPO of Lastminute.com. (LSE: LMC). Both companies seem to have been less than frank when dealing with third parties: the British Government, in the case of BMW, and the investing public in the case of Lastminute.com.
Elsewhere in the Fool we have covered the many different ways that we can examine the published financial data on a company. Although it is not quite true to say that the numbers cannot lie, they are at least audited. No such external refereeing is applied to the statements a company makes. Naturally, lawyers and advisors make sure that nothing incorrect is written in these statements. But, equally, there is an army of spin doctors -- including the press office, the investor relations office and the public relations consultants -- to ensure that the best possible spin is put on news good and bad.
It is our job, as investors and owners of these businesses to find out what is really going on with the company. Hopefully, these notes will provide some guidance.
As an example, look at this statement from Charles Cornwall of Eidos (LSE: EID) on February 28th:
We remain confident that the quality and depth of the release schedule will enable Eidos to meet the challenges facing all market participants in the next twelve months as the existing platforms begin to be replaced by the next generation of technology.
Then compare it with statement from the same man on 24th March:
The Company believes that these lower retail order levels are partly a result of the transition in the console markets to the next generation platforms, such as Dreamcast, PlayStation 2, Dolphin and X-Box. The Company anticipates that these new more powerful gaming platforms will have a positive impact on the market in the long term. However, the transition is likely to lead to a further weakening of current generation software sales in the near term.
In the first statement the company clearly realised there was a problem with consumer reluctance to buy their products while new platforms were being introduced. But he glossed over it with that classic phrase "we remain confident". Note, too, how that expression comes at the beginning of the sentiment, where it has most effect. What he is really saying is: "We know we have a problem but we hope it will go away".
The second statement contains that other great phrase of corporate doublespeak "The Company believes". As in this case, it often prefaces a plausible explanation of what has gone wrong and hence, by implication, a solution to the problem. However, what the company is really saying is: "At least we know where we screwed up; trust us not to do it again".
These two statements therefore demonstrate the first rules of corporate disclosure: always delay bad news for as long as possible. And they also contain two fantastic weasel phrases:
The Company believes
We remain confident
Whenever you see those words, raise your antenna and increase your guard.
Now let's turn our attention to Rentokil Initial (LSE: RTO), another company that has given investors a nasty taste in the mouth.
This is what the company said about its trading prospects for the rest of 1999 at the time of its interim results in August last year:
Continued growth in the higher margin businesses will continue to improve overall turnover, margins and profits but, in 1999, this growth will still be held back by the low margin activities. Our businesses in South East Asia are expected to improve from a much reduced base as the economies recover.
Notice again that the all the good news is in the first part of the paragraph. The grotty stuff is buried in the middle of the text and could easily be glossed over by someone skimming the text. Also note that the net effect of the statement is to leave the reader confused. Will the second half be better or worse? The company can't seem to make up its mind.
Then it goes on to say this.
The Board expects growth in profit and earnings for the full year to be in line with that in the half year. We expect the results for 2000 and beyond to be positively impacted by the revised strategy.
This requires the reader to think back to the results, which are hedged by caveats, so the effect of the statement is cover the company with a very broad weasel clause but not actually give investors much of an idea of the future.
So let's see what actually happened. Here is the statement it made at the time of its final figures:
Overall turnover growth was held back both by contract losses in low margin businesses early in the year (as referred to at the half year) and by lower growth in the turnover of our non-core activities which we are currently selling.
So it seems things turned out slightly worse than expected. But the company tries to partially excuse itself by referring to its earlier statement warning of the problems:
The 1999 results are in line with the Board's forecast made at the time of the interim results last year and represent sound growth of 10.5% in our core activities with our non-core activities also contributing to the overall growth of 10.3% to £541m.
In the summary of the results the Chairman picks out the good bits, the increase in core activities, and again excuses the figures by saying they are in line with forecasts. Chairmen seem to think it makes the figures slightly less painful if they say that they were expected to be bad.
When things get really tough, the language hardens as well. Look at this statement from Peter Salsbury, Chief Executive of Marks & Spencer (LSE: MKS) when he introduced the final results in May 1999:
We are in the middle of a rigorous review.
That means they have at last recognised that they have a very serious problem and are finally going to do something about it. It also means that the grief for shareholders is a long way from being over. But Sir Richard Greenbury, who got the company into the pickle in the first place, was still trying to make light of the situation. In his Chairman's statement he said:
I am confident that we will soon see the first signs towards a full recovery.
His "confidence" now seems misplaced. In the interim results, six months later, the company didn't even attempt to spin the numbers. It just put down the bald figures.
Group sales £3.7 billion (1998 - £3.8 billion)
Profit before tax and exceptional items £192.8 million (1998 - £337.4 million)
No percentage change or explanation, just a bald statement of the figure with the previous year's number tucked in apologetically alongside. That way they can't be held to account on anything they say. But the statement six months before about the "rigorous review" can now be seen in its proper light; a 43% fall in profits before tax in the next half-year. One wonders what Sir Richard's definition of "soon" is.
Another great way of minimising the bad news is to use the overall market as an excuse.
John Coleman, Chief Executive of House of Fraser (LSE: HOF) said this about his 1999 figures:
This is a strong performance in the context of the general retailing climate.
That sounds good -- what where the numbers? In fact sales growth was 2.3% and profits before tax were unchanged at £17.8m, after the £2.6m exceptional profit was stripped out. Not really a strong performance, is it? Sure, retailers were having a tough time last year but to claim a strong performance when earnings per share fell from 6p to 4.4p on a clean basis is stretching the use of both words to their very limit. And that 4.4p EPS figure was the adjusted one. It was not the 5.7p figure that the press release kept referring to, which included the exceptional gain.
This example is rather a case of a statement saying something that is blatantly not the case. By saying one thing in the text, even if it is completely at odds with what the figures are saying, the company can often get favourable press coverage and benign comments from lazy analysts.
The permutations of different ways of glossing over the unpleasant numbers are virtually endless and this article could go quoting examples for a long time. But I think we have made the point. The executives of the company and the PR firm have their mission to put the best possible interpretation on their figures. As an investor, or a potential investor, you have to learn to peer through the smoke and work out what the company is trying to hide.
In fact if there is only one thing to remember after reading this article it is this. Don't trust what the company says. Now I know there are a lot of straight-talking executives running companies who will be horrified by this accusation, and rightly so. But the problem is we don't know which ones are and which ones aren't. If you treat them all on the same basis, at the very lowest level of trust, then you aren't going to be disappointed.
If, over several years, you discover that a company generally does what it says, then it becomes a blue chip. I have a small list of companies I trust, but even then I read their statements with a critical eye. It may well be, for example, that they are locked in critical discussions with a large client or another company at the time of the results. Consequently, they are constrained by law from telling you everything. So even your trusted companies can surprise you. But, if they are good companies, the surprises will always be good ones.
The point to remember is that companies always know more than you do. As long as you keep that in mind when you read a company statement, you are less likely to get nasty surprises and profits warnings from stocks in your portfolio.
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