Even analysts with extensive accounting experience were blindsided by Enron and Worldcom! Become a Complete Fool
Only because they couldn't understand it but invested anyway.
I looked at both stocks during their heyday and went running in the other direction. And that was before evidence of massive fraud came out.
I looked at Enron. It was my type of company. I like companies that feed off of the commerce of others. I don't mean feed in a derogatory way. I mean companies that earn on override on economic activity, such as those selling advertising, or providing back office services to businesses. It is the old tollbooth theory; take a little off the top from everyone. I would rather sell insurance to car manufacturers than manufacture cars. I don't care which manufacturer is successful, they all need insurance.
Fortunately, I was also chased away from Enron because I couldn't understand just exactly how they made their money. And, I think what really worried me is that they were reporting huge profits in a type of enterprise that didn't even exist, at least to that extent, until just recently. Well, as it turned out, that industry really didn't exist.
To me, this is one of the biggest warning signs of investing. I ran into this again with Cendant. I don't remember the names of the companies involved that merged to become what we now know as Cendant, but one of them was cooking the books, just like Enron. I also couldn't figure out how that company was making as much money as it was reporting for what it was doing.
When you see a company that is reporting huge profits in some economic activity that is completely foreign to you, not because you are an uninformed person, but simply because such activity doesn't seem to fill an economic need of such magnitude, be very cautious.
This will keep you out of trouble much more often than it will cause you to miss some golden opportunity. Back during the tech.bomb mania, companies that were going to sell groceries over the Internet had multi billion dollar market caps. That was just so wrong.
If the books are too good to be true, they aren't.
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Even analysts with extensive accounting experience were blindsided by Enron and Worldcom!
Become a Complete Fool