The great investing myth (8): Trusting the company

Photo by Joshua Hoehne on Unsplash

Companies tend to articulate a bullish future with their compelling plan (also known as storytelling), especially with companies in early-stage, money-losing or those wanting to push up their valuation and share price. Their CEO and team can be charismatic with good showmanship, touting an enticing and inspiring thesis and future with nice and glossy presentations. It can get many excited and FOMO (fear of missing out) wanting to buy the stocks, causing the share price to surge with just the press releases and presentations, long before any substantiative results.

One area is the launching of new products that promise to be cheaper and/or better than existing ones; game-changing with lots of potentials. Examples: EV and EV-related startups, SPACs who are in pre-revenue or very early revenue stages, biotechs, and cryptos.

Companies may select and present their good operating and financial metrics (sometimes, misleading and half-truths as it does not represent the full perspective) to show their good progress (i.e. they select numbers and metrics to substantiate their “nice” stories).

When the operating environment is challenging and they are affected, they present a brave front and present what they have done right. Again, they will select metrics to show their resiliency. Their message to investors: have faith and be assured; keep holding and better, buy more; the situation will improve.

There are three kinds of lies: lies, damned lies, and statistics.

Mark Twain

New and inexperienced investors (without industry knowledge) based their investment decisions on these companies’ reports. presentations and press releases (i.e. believing and buying into their stories) and do not delve too much into their financial statements. They feel excited, convinced, confident or at least assured that their investments are in good hands.

Examples:
Some turn out very awry: WeWork, Peloton Interactive, Twilio, Grab, Meta Platform
Some turn out well: Apple, Amazon, Google, Microsoft, Tesla

Fact: No companies will tell us, the investors, that the company is not doing well or the share price is highly valued — do not buy or sell the shares.

Companies have to market themselves and their products to customers and other stakeholders (employees, suppliers, partners and shareholders). They themselves have to believe that they are good. They need to inspire and be confident no matter what.

Anything negative can lead to a confidence run — shareholders dumping their stocks, creditors and banks pulling their credit and employees demoralised and quitting.

Companies do not highlight their issues and challenges resulting in declining revenue and margins as well as debt level or weak cash flow; only when asked. While its financial performance has been mediocre or not good, the company keeps presenting that its fortune will change for the better with its new plans and products. Its biggest risk is often left unsaid. We have to judge for ourselves whether it is a crying wolf and whether it is worth investing in.

Sidenote: The same is applicable to others (analysts, gurus, friends) presenting their bullish case about investing ideas. We can get excited because of their experience, expertise or simply the way it was presented.

We, as investors, just need to be less gullible and improve our due diligence process to differentiate the good ones from the bad. Being investors, we have to know the business and its operating environment well and be able to exercise our independent thinking to evaluate whether their story is true and what is unsaid. We have to take responsibility.

Bluntly: Don’t trust the company’s bullshit!

This is similar to many other aspects of life. Our resumes present our achievements and strengths than weaknesses. Salespeople pitch a well-crafted sales pitch on how good their products are. Worse, scammers present a too-good-to-be-true investment. 🤦‍♂️🤦‍♀️

Nothing here; some hide their secret sauce
Some companies wrote minimally about what they have been doing, their achievements, their plan and outlook. They seem secretive about what they have been and will be doing. They let the results speak for themselves. They are secretive so that competitors will not know too much about their plans and specific progress. They do not intend to impress anyone.

A good example is Amazon.

  1. It hid its cloud computing business (Amazon Web Services) under the nondescript “Other” column for about 10 years. When disclosed in Q1 2015, the AWS 2014 revenue was already $5 billion and expected to grow to $6.26 billion in 2015; giving them a big lead over its competitors.
  2. It disclosed its advertising revenue for the first time in FY 2021 and it was already $31b. Again, its management made the decision to break out advertising on its own after considering how large a proportion it was encompassing in its other segment.
  3. It has not consistently disclosed its Gross Merchandise Value (GMV) for its e-commerce segment in its earnings. This makes comparisons with other retailers and e-commerce players difficult.

Warren Buffett said bluntly that most annual reports are a sham. Too many managers report with excess optimism rather than honest explanation, serving perhaps their own interests in the short term but no one’s interests in the long run.

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 candour benefits us as managers: The CEO who misleads others in public may eventually mislead himself in private.

Berkshire Hathaway, An Owner’s Manual, Owner-related business principles Number 12

Warren Buffett holds in high regard managers who report their company’s financial performance fully and genuinely, who admit mistakes, share successes, and are in all ways candid with shareholders. He admires managers who have the courage to discuss failure openly.

There are a few ways to evaluate the companies’ claims and these should be part of our investment evaluation process and checklist to construct our own conclusion.

Announcements and financial statements

Investors should study many quarterly earnings and annual reports than just relying on one report to conclude the claims of the company.

  1. What had management said about their strategies in the past? How consistent has their strategy been over the years? Have they been changing their strategies?
  2. How have they progressed with their past strategies and plans?
  3. How has their thinking changed with time?

The value of the management and their qualitative factors will show up in financial performance over time. The financial statements are important. They are the outcome and validation of the company’s vision, strategies and plans. It is good to track their long-term financial performance such as revenue growth, margin, profit growth, returns on equity and free cash flow over a few years or any other criteria. This help to evaluate (a) the quality of the execution of its strategy and (b) the consistency of its financial performance and its ability to handing various operating situations

Competitors’ financial performance

While some companies will self-praise how well and how resilient they have been, it is better to have some objectivity to compare to their competitors. How well are they doing and scoping? The same investing checklist can be used. How are the competitors faring in terms of revenue growth, margin, profit margin, returns on equity and free cash flow?