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Rat's Survival Alternatives
Instant Gratification

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By OtterPater
March 4, 2002

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Yo ratsters...

This is a philosophical/reflective post...it's been wandering around inside my head for a while, and I thought I would finally put "pen" to paper on it. The title is indicative of what I see in the market: everyone is looking for instant gratification in their investments, and you see it everywhere. You see it in:

* The Execcutive Suite: where the CEO's,COO's CFO's and other executives are supposed to be incentivized by stock options, etc., and where their bonuses are based not only on the financial results of a company, but also to the achievement of certain target stock performance levels. At this level, the product of instant gratification results in behavior, which is shortsighted, and sometimes improper. Look at Enron (ENE) and Global Crossing (GX) where the top brass manipulated the financials by setting up dummy transactions with controlled affiliates. [Senator Hollins, who sits on the Senate Finance Committee, never has figured out what an SPE is (Special Purpose Entity), but, in his own words..."We're gonna get rid of them."]

In the GX case, Global traded capacity (in the form of twenty year capacity contracts) on its fiber lines with another company that had capacity on its fiber lines (covering a different geographical territory) which permitted GX under currently accepted accounting practices, to record the sale side of the deal as immediate income, and the buy portion of the transaction on an amortized basis, which causes a distortion of what really happened: GX traded similar capacity here for similar capacity there, but with a nifty twist of the accounting pencil, it was recorded as immediate revenues offset by an accounting entry 1/20th its size. Result: they look real good in the financials, and the Executive Suite looks good, and the executives themselves hit their target numbers for bonuses, etc., all of which exacerbates the position of the average investor, who is really the one who is "paying" for all of this.

* The Professional Suite: The accountants, investment advisors and lawyers all work to play fast and loose with the myriad of rules coming up with endless gimmicks that have no real economic substance, but which, through close reading and manipulation of accounting and tax rules, end up looking good for their clients, who, in turn, pay dearly for this sophisticated advice. Now, understand something: I am a lawyer, and I spend my time trying to help my clients better their position in a transaction. But I gotta say that the accountants and the lawyers who represent publicly traded companies have lost sight of the fact that fancy footwork which results in great fees may not be in the best interest of the stockholders in the long run. At this point in time, a number of companies are dumping Andersen (Merck was the latest to do it) because of their aggressive accounting practices. And just pity the company that has its past financials brought into question...the market has consistently hammered those companies where there is even a whisper of past accounting issues. Wall Street has even coined a new phrase coming out of the ENE debacle: A company may be called enronized if the investing community thinks that they have relied on aggressive accounting practices to cook the books and look good in the short run.

* The Investor Suite: Yes...these attitudes are pervasive for investors, from top to bottom. Not just the little guy on the street, but the professional manager of a fund, who is constantly judged on the basis of "What have you done for me lately?" Today's hero is tomorrow's goat. It's that simple. And the average "Joe Investor?" He's in the same boat, because he has no choice, since the market now is so fickle in its aim at instant results (i.e. instant gratification) that it dumps quality companies not on the basis of what they have done, but on the basis of what their chart looks like. If the stock trends down for any reason...dump it and move on.

The go-go days of the late '90s basically managed to mask all of this...when the bull market erased all short-term memory of investing in companies with strong fundamentals and instead going with momentum plays, even though it resulted in buying companies with P/E ratios that were in the stratosphere. But hey...as long as the stock went up, you were a "hero"� or as I have said...a legend in your own mind. As a result of this drive to have "instant gratification", many managed to throw darts at the folks at TMF for their investing philosophy which is not based on instant gratification but, instead, is based on selecting sound companies with sound management, and watching them grow over time. Unfortunately, the pervasive current investing philosophy won't wait for long term, and folks get impatient if they don't see results immediately, and voila...you have folks who are very unhappy with the investing style of the Fool.

As to the latter point, I would be remiss in not saying that TA has its place in making investment selections. A look at the ENE chart would be instructional: although nobody (except the insiders) knew what was going on inside that company over the past 18 months, its chart looked like a blue ski run at Vail...all downhill from November 2000 on, which is something that an investor cannot and should not ignore. As TR (I like that, by the way...it has a nicer ring than just plain "trenchrat") says...read the charts! TA is just one tool in your investment analysis toolbox, and it is not to be ignored. But even folks over on the MI (Mechanical Investing) Board have an extremely short sighted view of investing which is largely due to momentum (which among other names comes out as "relative strength"), and less to do with the quality of what a company does, (or makes) or the quality of its management over the long run.

So...where do we end up with all of this? I must confess that I don't have any great insights (or, as I love the turn of the phrase, a blinding glimpse into the obvious). No one individual can return this market to its senses, where long term decisions are rewarded, and where management is more likely to consider the long run effects of its decisions rather than the short term impact that a particular decision will have on its short term stock performance. To be honest with you, I don't see the government having the solution either: we already have too much regulation, and the complexity of the tax code frankly is an open invitation to playing games. In short, you cannot legislate morality and ethics. What we need are business leaders who have integrity and character and are strong enough to be able to take the heat for decisions, which ignore short-term consequences. Those kinds of leaders are not going to "spring" for accounting gimmicks that dress up an ailing set of corporate financials.

Just my $.02.

Fool On.


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