Look Out! The Market’s Last Line of Defense Is Crumbling

Friday, May 20, 2016
By Paul Martin

by John Del Vecchio
DavidStockmansContraCorner.com
May 20, 2016

Two things about human nature are pretty predictable. The first is that humans have short memories. Second, they never learn from their mistakes.

The same goes for investors. Markets change, the companies that dominate the markets change, technology changes, but human nature never changes.

Not that long ago we experienced a huge financial crisis where many people watched their 401(k) turn into a 201(k). While the markets rebounded to new highs in recent years, a lot of individual investors sold at the bottom and never got back in. Others who did, won’t know to sell until it’s too late.

Meanwhile, central banks have fueled yet another bubble. This one could be even bigger than the last, meaning that when it bursts, it will burst more violently. Carnage will ensue, and some companies will be more devastated than others.

That’s why I focus so much of my energy looking at earnings quality.

In my newsletter Forensic Investor, I publish stock recommendations betting against companies that use accounting shenanigans – basically, companies that have jimmied their earnings. Often, companies will resort to this funny business to mask deterioration in their business. I also design, develop, and test models to help spot financial chicanery and predict where earnings could be vulnerable to manipulation.

The problem today is that the whole market may be manipulated.

More and more companies use these “adjusted earnings” to report their financial results. They often exclude all sorts of stuff from the numbers to make them look a lot better than they actually are. Measures like EBITDA for example (or “earnings before interest, tax, depreciation and amortization) mask material weaknesses in the financials. Warren Buffet calls it: “earnings before the bad stuff.”

But the biggest prop to the market may be share buybacks.

The Rest…HERE

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