Monday, June 11, 2012

Value Indicators: Accounting Changes, Discontinued Ops, Extra-Ordinary Items

For this indicator I'm using a new feature in Verdasis called "Fast Exports" where you can down-load entire financial statements into excel. I could have accomplished the same thing with the analysis templates, but I don't know, I felt like shaking things up.  There are so few opportunities to pierce your eye-brow and dye your hair pink, figuratively speaking, when you're doing investment analysis.

The How-To:
1) I took my list of securities that I'm analyzing, the US Integrated Oil & Gas ones, and then clicked open the "fast exports" tab on the left.  I then clicked "Financial Statements (beta)",
2) I entered my first security, PBR into the security field and choose "PBR:NYSE" from the list.  The financial statement is "Income Statement", reporting interval is yearly, I selected all of the available years by choosing the bottom year, holding the "shift" key down, then clicking the top year.
3) Click "OK" when the pop-up window asks if you want to open with Microsoft excel.  Click "enable" on the next box.
4) After clicking in the affirmative on those above mentioned pop-up windows you'll wind up with an excel spreadsheet that will display several years of income statements for the security you entered.
5) Scroll down and see if there are any entries for Accounting Changes, Discontinued Ops or EO Items.  They will be in rows 23, 24 and 25 respectively.

For this indicator, I'm just eye-balling the results, rather than writing an logic equation.  Why? Just faster for the purposes of this blog analysis.  There are advantages to writing the logic equation, number one being that it will always stay up to date.  So for that reason, I probably should, but I'm not.  I won't apologize. 

Ideally, you want to see all zeros from B23 to F25.  This indicator is rather akin to the quality of earning indicator in that it gives you a sense of how much faith you can put into the statements themselves.  These three classifications open up the possibility of abuse as they can mask and manipulate actual results.  Let me give you a couple of examples:
 1) Management decides to reduce the rate at which capital items are amortized.  Now, the reason could be perfectly legitimate - it could be more reflective of what the industry as a whole does or it could be more indicative of their actual consumption.  Or it could be an effort to reduce expenses and pump up earnings.
2) "Unusual" transactions that have a detrimental effect on earnings are classified as extra-ordinary whereas similar type transactions that have a positive effect on earnings are classified as operational.

However, sometimes management should use those categories.  Sometimes accounting changes are mandated by GAAP, sometimes you really do discontinue operations and sometimes there are acts of God.

So, arbitrarily, I make the following rules:

The company can earn a rating of one if all of the following are true:
  • The company records one or zero items in the past three years,
  • The company records one or zeros items in years Y-3 or Y-5,
  • The company records no more than two items is years > Y-6.
The company can earn a rating of zero if the following is true:
  • The company records two items in the past three years,
  • The company records two items in the years Y-3 to Y-5,
  • The company records no more than three items in years > Y-6.
If everything is false, then the company earns a rating of -1.

To see the spreadsheet click here.

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