On the art of finding partners in unexpected places.

It’s funny to me how even the most arcane accounting diatribes seem to exhibit seasonal patterns, like the quarterly GAAP1 versus non-GAAP spitting contest. Funnier still, you can almost smell the presence of politicians and overzealous regulators (the minimum-common-denominator rule makers) lurking in the shadow of any financial acronym. Like herds of Pamplona-ready bulls in front of a red cloth, they prepare to barrel head-first into furious debates on how to protect what ultimately cannot be protected (the careless investor).
   Things currently stand as follows. The official books of any publicly-traded company have to follow GAAP, and this applies to all communications with the investor community. The management of any company can also report figures which do not reflect strict GAAP standards (the “non-GAAP financials”) to provide investors with additional information they deem useful in evaluating the performance of the business. (Buffett and Munger have been doing this for ages in Berkshire Hathaway’s annual reports, saying they want to show investors how they think about the businesses over time.) Critics and active proposers of change say that today’s managements, analysts, press, on-line financial sites, and investors have all forgotten about GAAP and only look at non-GAAP (operating, core, continuing operations, organic, etc.) figures; hence, the call to action. There is some truth to this but the problem won’t be cured by additional rules; knowledge, patience and attention to details on the part of the investor will.
   In the context of premeditated fraud, of which unfortunately there are many examples, the practice of aiding (gently cajoling?) financials’ interpretation via management-concocted fluff is deplorable. But to legislate the entire production of financials on the basis that all management teams are fraud-prone seems a bit extreme to me. Especially when you note that the production of non-GAAP figures is in addition to the whole gamut of GAAP numbers and footnotes, and that management is obligated to disclose a reconciliation between the two sets of figures. Also I’d like to point out that all additional information management provides is useful, for one very simple reason: managers are the people – partners, really – who will shepherd the assets of your company and a peek inside their thinking will tell you a lot about who you’re really in bed with. That will come very handy when considering any single stock investment and may actually save you a bundle.

Investing, to paraphrase Charlie Munger, is not supposed to be easy. As the target for the additional disclosure rules are individual investors, it should be noted most of the latter will never have the know-how to dissect a balance sheet or interpret a cash flow statement regardless of how many rules you put around their production. That’s why in all likelihood most investors would be better off putting their money in diversified index funds.


Notes: 1. Generally Accepted Accounting Principles, as enunciated by the FASB, Financial Accounting Standards Board, responsible for the standards of financial accounting that govern the preparation of financial reports by nongovernmental organizations.

Photo source: http://seekingalpha.com/article/1519672-trust-but-verify-gaap-versus-non-gaap