The Enron accounting scandal hasn’t touched directly our recommended individual stocks. Not all of our picks have been winners in the bear market, but we’ve avoided accounting and management scandals.
It takes a bit of work to avoid companies with artificial financial results, and it is not always possible. A concerted fraud effort is impossible to detect from the outside. But there are some key signs to be alert for.
Cash flow. A good company has positive cash flow, and the cash flow should be increasing. One problem with many companies in the last few years is that they would make non-cash deals. Products and services would be sold in return for stock. Or revenues would be booked, though cash wouldn’t be received for several years, if ever. Or the sale would be contingent on the seller buying goods or services from the buyer. In other words, the revenues would be offset by expenses. Growing sales with declining cash are a danger sign.
Big charges. One way companies manage earnings is to write off expenses as nonrecurring charges or unusual items. That way, analysts and investors will think they are one-time events that should be ignored when evaluating the long-term health of the company. When a company reports “nonrecurring charges” on a regular basis, that is a sign of trouble. Also, it pays to examine the nonrecurring charges. Often, there are routine expenses lumped into this category.
Related transactions. Corporate cash often is used to enhance executive lifestyles. Good managers should be well-compensated. But big loans to buy homes or corporate stock can be a warning sign. It also is not a good idea for a company to lend money to its customers. In essence, the company is buying its products from itself.
Rising receivables. If customers aren’t paying on time, trouble is on the way. Rising revenues are nice, but not when they are accompanied by an increase in accounts receivable. Too often, a big chunk of those rising receivables will be written off and the earnings re-stated.
Sustainable returns. Many companies find ways to boost profits from one-time events. Some have a trading operation that might make big profits one year. Others sell assets. The methods are only as limited as the imagination. A good investor will examine sources of revenue to ensure that the growth is sustainable.
For new readers, I have a list of recommended individual stocks for those who want to venture from mutual funds. These are long-term core holdings. I don’t report on the stocks every month. Instead, I’m looking for companies that are good to own for a long time. I recommend a sale only when I think a better opportunity is available or when the long-term success of the company is in doubt. Full details of the recommended stocks are on the web site. Let’s review the stocks and make a couple of changes.
We’ve had some market leaders in the recommended stock portfolio.
Adobe is a leader among recovering technology stocks. Its software is in demand and will benefit from the economic recovery. Dell Computer continues to take over the personal computer industry while expanding into servers and other fields. Wal-Mart has used its low price reputation to increase sales during the recession while many other retailers had flat or declining sales. The company is richly valued now, so don’t add to holdings.
Johnson & Johnson was a strong performer throughout the bear market, as was Progressive Corporation, a leading auto insurer. Choicepoint, which sells computer software and services, dipped at the start of the bear market but is up over 25% for the last year. Tribune Company has had a strong recovery in anticipation of a recovery in advertising spending.
Harley Davidson had bad press recently as a few analysts re-surfaced the argument that the motorcycle-maker’s sales were peaking. The fact is that there still is a long wait for new bikes. The stock is down about 5% for the year but will soon be back on the rise.
I am recommending two sales and two new purchases.
Triquent Semiconductor has done poorly in the technology bear market. Triquent’s customers aren’t likely to recover for at least a year. It’s sale. Also sell Charles Schwab & Co. This still is a quality, leading company that will grow in coming years. But I think there are stocks with better prospects.
H&R Block (HRB) is the leading tax preparer in the country, preparing almost half of all tax returns. Its efforts to branch into mortgages and financial planning are taking hold. With scant prospects of the tax code being simplified, Block should be able to increase its tax preparation business and convert some of those customers to its new businesses.
Duke Energy (DUK) is a leader in the energy business and will continue to grow. It held on to its power plants and pipelines while Enron and others were unloading theirs. Duke is successfully executing the strategy that Enron claimed to be following. It has a trading operation, but it only trades products that Duke produces and distributes. It has a lot of assets, a top credit rating, and solid prospects for well-managed growth.
The surest way to simplify your financial life and boost investment returns is to consolidate your portfolio.
At Retirement Watch we’ve been at the forefront of encouraging investors to put all their investments in accounts at one or two brokers or fund families. The result is all your information on one statement, one phone number to call, and one web site to visit. You’ll spend time managing your investments, not trying to figure out what you own.
Below are my recommended discount broker no-transaction-fee funds and Vanguard funds to supplement my regular recommended funds. This list is not a recommended portfolio. It shows my preferred NTF and Vanguard funds in each category. You can substitute relevant funds for the recommended funds in my regular portfolios. That will give you similar investment returns, reduce transaction costs, and simplify your financial life. Earn higher returns while spending less time and money investing.
No Transaction Fee and Vanguard Recommended Funds
|Fund Category||NTF Fund||Vanguard Fund|
|Core Stocks||Am. Cent Inc & Growth||Total Stock Index|
|JP Morgan Tax Aware US Equity|
|Large Value Stocks||Oakmark Fund or Oakmark Select||Value Index|
|Excelsior Value & Restruc.|
|Selected American Shares|
|Large Growth Stocks||Gabelli Growth||Growth Index|
|Marsico Focus||Growth Equity|
|Transam. Prem. Equity|
|Small Value Stocks||Heartland Value||Small Cap Value Index|
|Third Avenue Funds|
|Diversified International Stocks||Oakmark International||Global Equity|
|Am. Cent.Int’l Growth|
|Am. Cent. Int’l Discovery|
|Oakmark Int’l Small Cap|
|Emerging Market Stocks||Am. Cent. Emg Mkts||Emerging Mkt Stock Index|
|Latin American Stocks||ABN Amro Latin Am.|
|Asia Stocks||Matthews Pacific Tiger||Pacific Index|
|General Bonds/Income||PIMCO Total Return||Total Bond Index|
|Schab Total Bond Mkt Index||Interm. Bond Index|
|Columbia Fixed Income||Interm. Corp. Bond|
|GNMA Bonds||Am. Cent. GNMA||GNMA|
|High Yield Bonds||Columbia High Yield||High Yield Corporate|
|Transam. Premier High Yield|
|Sectors||Cohen & Steers Realty Shares||REIT Index|
|Firsthand Technology Value||Health Care|