The Games Companies Play

“Many a man has fallen in love with a girl in a light so dim he would not have chosen a suit by it.” – Maurice Chevalier

The more I’m wined and dined by a potential business partner or a company I’m thinking of recommending to my readers, the more I ask myself: “What are these loquacious people sitting across the best table in the best restaurant in the city hiding from me?”

Fifteen years ago, I was a lot more trusting than I am now. I’m not saying that having faith in other people is a bad thing. But blind faith is a different thing altogether. This is a lesson I learned the hard way.

In the early days of my global business dealings, I was introduced to a company in Kuala Lumpur that loved our products and wanted to represent us. The company came with good credentials, but was somewhat small.

I had about a dozen meetings and half a dozen dinners with its president, a dynamic guy named Maruap. He told me, over and over again, that we would be his most important client, and that he would do everything possible to get us more business in Malaysia than we could handle. In fact, he said we were so important that he would put his brother, the vice president of the company, in charge of marketing us.

And because Maruap and I bonded, his company’s stature steadily grew in my eyes – even though it did not grow by one employee over the course of our meetings. At the end of my second visit to Kuala Lumpur, I was hooked and signed on.

Then I discovered two disturbing things.

Maruap was engaging, bright, and a born leader. He had told me how he’d grown up dirt-poor in a tiny village, and how he started his company with a $500 loan from his grandfather. I assumed his brother, Sahat, was made from the same mold. But nothing could have been further from the truth. Sahat was a sweet guy – honest and sincere. He was also bookish, shy, and soft-spoken. When he spoke – unlike his brother – nobody listened.

In addition to the fact that Sahat turned out to be a pale imitation of Maruap, I learned that the company did not have the reach into certain parts of the country where the potential for grabbing business was significant.

It was a less-than-ideal situation, and I had nobody to blame but myself. (By the way, Malaysia did end up becoming a great market for us, but not until I replaced Maruap’s company with another one.)

Maruap didn’t lie to me. He was, in fact, not guilty of anything except putting his best face – and that of his company – forward. All the same, I was snookered. And this kind of thing happens all the time… not only in business but also with investments.

For example, if you think an annual report is meant to give you an accurate picture of the company, think again. It’s meant for one thing only: to put forward the company’s best face.

Earnings presentations can be even more misleading. Like partisan pundits discussing a just-concluded presidential debate, it’s all about spin. In earnings calls, the company is going all out to accentuate the good news and relegate the bad news to the background.

Here’s some of the spin I remember hearing over the past year. They’re not exact quotes, but they capture the gist of what was said:

• “Fees are down, but from a generally high rate level.”
• “Our bank withdrew its loan, but this is just a chance to get a better loan from another bank that is truly on our side.”
• “Some major orders we got at the end of the quarter weren’t delivered. This gives us a running start on next quarter.”
• “Our sales have gone down, but our inquiries remain strong.”

Now, these aren’t outright lies. But they are good examples of how the truth can be stretched to paint a picture of a thriving company.

And even in one-on-one meetings, CEOs stay on message. They only tell you what they want you to know. Most are extremely articulate, and they can be forceful and charming at the same time… much like Maruap, my old partner in Kuala Lumpur.

But is there a Sahat lurking behind the bright facade painted by these CEOs?

Maybe.

Can you find out for sure by dialing into their earnings presentations? Or by trekking out to company headquarters for a chat with company executives? Is it even worth reading annual reports, if they can be so misleading?

Yes, yes, and yes – but you can’t be guileless about it.

6 Shortcuts to the Truth

1. The sound of silence is telling.

Listen as much to what a company isn’t saying as to what they are saying. For example, if they are in a technology war with a competitor and they say the competitor’s technology isn’t as good as they think it is… that the competitor is arrogant… that the competitor is spending too much money… stop and think. All you want to hear is that the company itself has technology that’s as good as, if not better than, their competitor’s.

To see what I mean, check out how Intel and Advanced Micro Devices talk about each other.

2. Whole sectors are capable of falling off the cliff.

Don’t fall for the “misery loves company” argument. It can take many forms, like “We’re not worried about rising costs, because our competitors are even worse off”… or “Our sales are holding up quite well compared to our peers”… or “Sure we have high debt, but that’s a characteristic of the sector we’re in.”

3. The devil is in the details.

When you read a company’s annual and quarterly reports (and you should read them), also read the footnotes. Then go through the report again and read only the footnotes. Even if you don’t find any deal breakers, you can learn a lot from what the company wants to hide from plain sight.

4. Noisy earnings are trouble.

Earnings can get skewered by a lot of one-time and end-of-quarter events. Plus, they’re overrated. Look at cash flow from operations or EBITDA (earnings before interest, taxes, depreciation, and amortization). They more accurately reflect how much money comes in and out of a company.

5. It’s okay to like the story… but not if that’s all there is.

I love a good story. But it should be subservient to the numbers, the technology, the killer business model, or the growing sales. When The Story is a company’s main pitch… well, enjoy it. Just don’t invest in it.

6. It all comes down to customers.

The “Management Discussion and Analysis” part of a company’s report ranges from bad and self-serving to really bad and self-serving. Skip directly to the discussion about its customers. That’s where you can find out, for example, if 80 percent of sales are from two customers (bad)… and one of them is from Venezuela (very bad)… and the other just indicated that they’re switching suppliers (very, very bad). The number, diversity, and size of a company’s customers reveal a great deal about the quality of its earnings.

Okay, those are my official tips. Now, here are some very unconventional ways to see right through a company. I’m sure you’ve never seen them before… and you’ll never see them again.

• Look for real confidence.

I love it when the CEO or another company exec is abrupt with me. It means they’re not overly concerned with impressing the hell out of me. If they’re that confident about their company, GREAT. I’m buying. (This advice applies to U.S. companies only.)

• Beware of the repeating phrase.

One CEO kept repeating one thing over and over to me: “The market will eventually recognize our true value.” He did it so much, I began to suspect he believed the exact opposite. Oh, the market finally did recognize that company’s value … but it took 15 months.

Another CEO kept telling me, “We’re a product machine.” At about the fifth iteration, I finally got it. What he was saying (to himself) was, “Yeah, but can we sell all that stuff?”

• Sniff the air.

When I visit a company, I look around and observe the employees as much as possible. Is there panic in the air? Depression? Or an air of quiet productiveness? If I weren’t so Old School, I’d put it this way: “Is the energy good or bad? If it’s bad, I don’t care what the numbers tell me. I’m holding off on my recommendation.”

I evaluate a company in this order: numbers first, followed by earnings reports and other SEC filings. And I end by hearing out the company execs.

What I hear can confirm a good evaluation – but it can’t trump a bad one. If I don’t like a company, I’m not going to let those boys change my mind. They may be trying to pull the old Sahat-for-Maruap trick. And I’ve been there.

[Ed. Note: Andrew Gordon, ETR’s Investment Director, has authored several books on energy markets, global countertrade practices, and the hot growth sectors of China and Russia. A former professor of marketing and finance, he is the editor of INCOME, a monthly financial advisory service that uncovers income-generating stocks that promise safety (first and foremost), along with much-higher-than-average profit potential.]