Pennsylvania Investment Observer

Here Come the Chickens (Home to Roost)

by Daniel J. Nestlerode

We've had a pretty good run in stock prices over the past several years. Now, with Alan Greenspan nudging interest rates higher (a total of 1.75% as of last May), the economy is slowing and the stock market has entered a corrective phase. That is Wall Street lingo for a down market complete with lower stock prices. Some of the excesses that were hidden in the rising stock market and expanding economy are now coming home to roost.

Here are a few of the "excesses" or abuses that were hidden in the good times of rising stock prices. These abuses will be publicized and corrected in the coming months. They will, however, be associated with stock prices falling further than might otherwise be the case. Part of the problem lies with those investors and managers who are dedicated to growth at any cost, including fiddling with the numbers. Here are a few practices that investors may want to eliminate from their portfolios.

1. Companies, especially tech companies that have overstated profits because of the widespread use of employee stock options in place of payroll compensation. Options are not generally treated as a corporate expense, yet their nature is to replace higher payroll costs. One analyst believes that the S&P 500 companies overstate their profits by 6% because of this issue. Some individual companies might have significantly larger overstatements.
2. Many companies have created investment portfolios that, until this year, added significantly to earnings growth. Now with the stock markets down for the year, you can expect these former profit centers to be loss centers. Cisco and Intel are two examples of this practice.
3. A number of companies had reduced or eliminated funding their pension fund obligations because the rising stock market was doing the job for them. Now, however, many of these companies are going to have to start funding these obligations this year, lowering profits. General Electric and General Motors, among others are examples of this practice.
4. Some high technology companies have loaned money to their customers to maintain their rapid rates of growth. Some of these equipment "sales" are now turning into uncollectible debts. Perhaps the sales should never have been made in the first place. At the very least, sales will slow and write offs will fall to the bottom line, reducing profits.
5. Mergers and IPO financings. Without getting into accounting rules and standards, you need to realize that a vibrant stock market covered up many ills. A falling one amplifies these ills. Look for restatements of earnings from prior years and other techniques to bury problems that are now coming home to roost.

Many folks believe that they can truly manage their own portfolios and keep current with the times. If you are one of those folks, then add to your research by reading, "The Analysts' Accounting Observer". If reading about accounting doesn't appeal to you, maybe you should get some help with your portfolio.

top of page | article archive

Home | About Nestlerode & Loy | Company News
Traditional Brokerage | Discount Brokerage | Investment Management
Investment Research |  Investment Articles

Privacy Policy

1-800-922-7492
Contact Nestlerode & Loy

©1997-2007 Nestlerode & Loy, Inc.