Short-Termism And Corporate America: Who Can You Trust?
By Eben Esterhuizen, CFA: When you invest in a company, you're essentially placing your financial fate in the hands of the executives who run it. Just one little problem with that arrangement--your goals and the goals of the management team may not be always be aligned...
Before you bet the farm on a company's stock, stop to consider what motivates its management. You might be a buy-and-hold investor, but the managers of most major corporations are more concerned with reaching short-term targets. The reason? Their annual stock option bonuses depend on the performance of the company's stock price. This incentivizes practices that lead to short-term results, even when they come at the expense of long-term growth.
Case in point: In a 2006 survey of financial executives conducted by professors at Duke and the University of Washington, 76% freely admitted that they would sacrifice economic value to keep earnings rising at a clip.
And another survey of more than 400 financial executives showed that 80 percent of the respondents would decrease discretionary spending in areas like research and development in order to meet short-term earnings targets.
Not that short-term growth is necessarily a bad thing--but practices that bolster immediate earnings don't always translate into sustainable, long-term growth. For instance, big companies commonly boost their short-term earnings by acquiring smaller companies. But it's not a business model for long-term success; after all, they can't very well go on making acquisitions forever. This kind of fast-paced growth just isn't sustainable.
Even Warren Buffett admits that "short-termism" is taking its toll the U.S. economy...
"We believe that short-term objectives have eroded faith in corporations continuing to be the foundation of the American free enterprise system, which has been, in turn, the foundation of our economy," according to an Aspen Institute statement, signed by Buffett.
The bottom line: If you're a long-term investor, you need to find companies that share your vision for sustainable growth, and avoid companies that use accounting gimmicks to inflate earnings results.
So how do you scope out the trustworthy companies?
That's the (multi) million dollar question--we found the experts that can help you find the answers...
Audit Integrity, an independent financial analytics company based in Los Angeles, has developed a proprietary model to identify high-risk accounting and management practices.
Audit Integrity looks beyond the raw data reported in companies' income statements and balance sheets to more than 100 factors that help it assesses the true quality of corporate accounting and management practices.
The company "has back-tested its proprietary metrics to 1996 to establish correlations between corporate behavior and negative events. The result is its Accounting & Governance Risk rating, or AGR, which is a percentile score ranging from 0 to 100, with corresponding ratings from Very Aggressive (lowest scores) to Conservative (highest scores)."
According to Forbes, "companies rated Very Aggressive or Aggressive have proven to be much more likely to suffer severe equity loss and to face class action suits and financial restatements," while "those consistently rated Conservative have been shown to be the most trustworthy."
Here's a list of 20 companies with the highest AGR ratings. According to Audit Integrity, these are the companies you can trust:
1. Bancorp Rhode Island (BARI): Regional Bank
2. Hawaiian Electric Industries (HE): Electric Utility
3. Hot Topic (HOTT): Apparel Store
4. Patterson Companies (PDCO): Medical Equipment Wholesaler
5. Transatlantic Holdings (TRH): Property & Casualty Insurance Provider
6. TrueBlue (TBI): Staffing & Outsourcing Services Company
7. Westfield Financial (WFD): Regional Bank
8. Overhill Farms (OFI): Processed & Packaged Goods Provider
9. Allied Healthcare International (AHCI): Home Health Care Provider
10. Art Technology Group (ARTG): Internet Software & Services Provider
11. Chemed (CHE): Home Health Care Company
12. Citi Trends (CTRN): Apparel Store
13. Curis (CRIS): Biotech Company
14. National Interstate (NATL): Property & Casualty Insurance Provider
15. Occam Networks (OCNW): Networking & Communication Devices Company
16. StarTek (SRT): Staffing & Outsourcing Services Company
17. United States Cellular Corporation (USM): Wireless Communications Provider
18. WD-40 Company (WDFC): Specialty Chemicals Company
19. TriQuint Semiconductor (TQNT): Builds Integrated Circuits
20. Westlake Chemical (WLK): Specialty Chemicals Company
Before you bet the farm on a company's stock, stop to consider what motivates its management. You might be a buy-and-hold investor, but the managers of most major corporations are more concerned with reaching short-term targets. The reason? Their annual stock option bonuses depend on the performance of the company's stock price. This incentivizes practices that lead to short-term results, even when they come at the expense of long-term growth.
Case in point: In a 2006 survey of financial executives conducted by professors at Duke and the University of Washington, 76% freely admitted that they would sacrifice economic value to keep earnings rising at a clip.
And another survey of more than 400 financial executives showed that 80 percent of the respondents would decrease discretionary spending in areas like research and development in order to meet short-term earnings targets.
Not that short-term growth is necessarily a bad thing--but practices that bolster immediate earnings don't always translate into sustainable, long-term growth. For instance, big companies commonly boost their short-term earnings by acquiring smaller companies. But it's not a business model for long-term success; after all, they can't very well go on making acquisitions forever. This kind of fast-paced growth just isn't sustainable.
Even Warren Buffett admits that "short-termism" is taking its toll the U.S. economy...
"We believe that short-term objectives have eroded faith in corporations continuing to be the foundation of the American free enterprise system, which has been, in turn, the foundation of our economy," according to an Aspen Institute statement, signed by Buffett.The bottom line: If you're a long-term investor, you need to find companies that share your vision for sustainable growth, and avoid companies that use accounting gimmicks to inflate earnings results.
So how do you scope out the trustworthy companies?
That's the (multi) million dollar question--we found the experts that can help you find the answers...
Audit Integrity, an independent financial analytics company based in Los Angeles, has developed a proprietary model to identify high-risk accounting and management practices.
Audit Integrity looks beyond the raw data reported in companies' income statements and balance sheets to more than 100 factors that help it assesses the true quality of corporate accounting and management practices.
The company "has back-tested its proprietary metrics to 1996 to establish correlations between corporate behavior and negative events. The result is its Accounting & Governance Risk rating, or AGR, which is a percentile score ranging from 0 to 100, with corresponding ratings from Very Aggressive (lowest scores) to Conservative (highest scores)."
According to Forbes, "companies rated Very Aggressive or Aggressive have proven to be much more likely to suffer severe equity loss and to face class action suits and financial restatements," while "those consistently rated Conservative have been shown to be the most trustworthy."
Here's a list of 20 companies with the highest AGR ratings. According to Audit Integrity, these are the companies you can trust:
1. Bancorp Rhode Island (BARI): Regional Bank2. Hawaiian Electric Industries (HE): Electric Utility
3. Hot Topic (HOTT): Apparel Store
4. Patterson Companies (PDCO): Medical Equipment Wholesaler
5. Transatlantic Holdings (TRH): Property & Casualty Insurance Provider
6. TrueBlue (TBI): Staffing & Outsourcing Services Company
7. Westfield Financial (WFD): Regional Bank
8. Overhill Farms (OFI): Processed & Packaged Goods Provider
9. Allied Healthcare International (AHCI): Home Health Care Provider
10. Art Technology Group (ARTG): Internet Software & Services Provider
11. Chemed (CHE): Home Health Care Company
12. Citi Trends (CTRN): Apparel Store
13. Curis (CRIS): Biotech Company
14. National Interstate (NATL): Property & Casualty Insurance Provider
15. Occam Networks (OCNW): Networking & Communication Devices Company
16. StarTek (SRT): Staffing & Outsourcing Services Company
17. United States Cellular Corporation (USM): Wireless Communications Provider
18. WD-40 Company (WDFC): Specialty Chemicals Company
19. TriQuint Semiconductor (TQNT): Builds Integrated Circuits
20. Westlake Chemical (WLK): Specialty Chemicals Company
Disclosure: At time of writing, Eben Esterhuizen did not own any of the securities mentioned above.
(Edited by Alicia Sellitti)
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