Starts out innocently, it does. Fair-haired youth, a bit rambunctious, explores his craft under the direction of a wise tutor. But soon, enticed by power and pecuniary promise, he is. Thoughts turn to the dark side, to the path of least resistance. Far off and difficult to see are the rewards of right path. Tempting and immediate are the rewards for straying into shadow.
Yoda's words about Anakin Skywalker? Heck no, this is what Yoda is telling me. (So I hear Yoda... hey, everyone's got a flaw or two.)
Street Wars: Revenge of the Seth
Some days, it's tough to remain a good and ethical Fool. That's because while combing through the SEC filings of (ahem) legitimate businesses, I am continually amazed at just how simple it is to take money from investors and squander, misappropriate, waste, or even steal it. I'm not just talking about convicted looters like WorldCom's newest con Bernie Ebbers. Unfortunately, otherwise respectable companies, with real products and real earnings, find plenty of ways to transfer wealth to a select few, at the expense of the many.
Frequent are the days when I look up, shocked and horrified, from an SEC filing, and then hear a raspy, hooded, vaguely European voice creeping into the back of my head, hissing, "Why not use this new power, young Jedi? Why not create a Canadian mining shell, rack up years worth of paper losses, then sell the whole shebang for a pile of cash to the latest L.A. fashionista who wants to create a torn-jean empire? Could you not buy stock in some slick-sounding but unproven nanotech and then hype the heck out of the shares?"
But then the voice of Yoda creeps back: "Stay the path, dude-meister." (OK, so my internal Yoda is a bit different from that green puppet on the big screen.)
So this one's for my internal Yoda -- a brief look at some of the most common ploys of the stock-market Sith.
The Jedi mind trick
Back on planet Earth, this is usually performed via the press-release game. Small, thinly traded companies in hot sectors are able to exploit the simple-minded masses with a few well-placed words. Check out the recent swings at Altair Nanotechnologies (NASDAQ:ALTI), for instance, which reported a 600-plus percent increase in revenues today.
Don't be too impressed. Giant percentage gains are easy to get when you're starting from nearly nothing. The 31% increase in net loss and 15% share dilution didn't make it into the headlines. But the stock is doing just fine today, up 12%.
Taser International (NASDAQ:TASR) pulled a similar maneuver recently, which worked amazingly well to blind the market to the distinct lack of information regarding the previous quarter's meltdown.
(Waves hand) "These are not the numbers you are looking for."
Don't fall for that, Fool.
The Jedi growth trick
Unfortunately, major growth, even when it's real, isn't enough to reward shareholders. KrispyKreme (NYSE:KKD) anyone? With a great product, plenty of PR, cheap interest rates, and a slavish media willing to heap praise on you no matter what kind of moves you make ("A Krispy Kreme near Uncle Owen's moisture farm? Genius!"), it's very easy to grow too fast, without investors being much the wiser. Until they do get wiser. At that point, the light saber falls, sometimes quickly, sometimes with 1,000 cuts.
The only way to avoid this trap is to be diligent in reading the quarterly operating results and to really understand the business. As it turned out, Krispy Kreme didn't scale so well. And the allure of hot doughnuts was not enough to support continued, organic sales growth once the shops were in place.
The Jedi cash trick
Perhaps we Fools are part of the problem here. We often profess a clear preference for companies that are cash-rich. But we need to qualify that. As Bill Mann (our office Yoda) explains here, cash isn't always so good. Why not? Because a business that keeps too much of it around is admitting that it can't find anything productive to do with it. Or worse.
Take Apple (NASDAQ:AAPL) for instance. Nearly every article discussing Apple's valuation makes reference to its enormous cash horde as if this is some great thing. Poppycock. Apple doesn't need that cash. Apple isn't using that cash -- at least not yet. But I'll eat a whole, roasted Ewok -- zipper and all -- if Apple doesn't find a use for it soon enough, and a bad one: soaking up the massive stock dilution that it's inflicting on shareholders. In all likelihood, such a payback will come under the guise of "enhancing shareholder value." At that point, the cash that shareholders now think of as theirs will have successfully been transferred to management and employees, who, thanks to our lagging accounting rules, get a big chunk of pay in options, the expense for which does not appear on the income statement. (Yay! Everybody wins!)
Don't fall for it, Fool. Cash that's not being deployed at high rates of return (and Apple's are none too impressive) should be coming back to shareholders.
Bureaucratic fog
And you thought those mind-numbingly boring scenes of intergalactic parliamentary procedure were nothing more than a good opportunity to hit the head and refill the popcorn tub. Tsk, tsk, young Jedi. While you were escaping Jar Jar's annoying, Rastafarian filibuster, you forfeited an important lesson: Evil lurks in those boring and loathsome details.
Hollinger International, Enron, AIG (NYSE:AIG). The common denominators in all these scandals are thick layers of management, outside interests, off-balance-sheet entities, and other smokescreens designed to mask costs, camouflage payment to managers, hide liabilities, and inflate revenues. A Foolish rule of thumb: If you can't figure out where the money is coming and going by consulting the big three financial statements, don't put your money on the line.
Jabba the Hutt-sized pay packages
Bloated pay packages are not just for maggot-like galactic Mafiosi. They afflict businesses big and small, and are often completely at odds with shareholder interests. I recently got the chills when looking into billboard denim superstar True Religion because the CEO takes the greater portion of his cash payout straight off the top -- a 3% cut of company revenues.
But, as Rick Munarriz points out today, management grabs aren't limited to little companies. Blockbuster's (NYSE:BBI) CEO John Antioco is locked in an epic duel with billionaire shareholder Carl Icahn over, among other things, Antioco's huge bonuses, which come despite the firm's continued, crushing losses. In addition to a big salary, ex-con Martha Stewart gets straight appearance fees, plus a guaranteed bonus from Martha Stewart Living Omnimedia (NYSE:MSO), no matter how horribly her company performs.
Worse yet, it's possible -- indeed likely -- that major failure will pay off no matter whether the captain stays with the ship or heads for the escape pod, elbowing the women and children out of the way. (Ah, the advantages of sitting in the high-backed chairs, where you get to dictate the terms of your compensation by stacking the board.) Just look at the sweet getaway made by HP's fallen glam gal, Carly Fiorina.
Sandal-footed padawans who seek to steer clear of such shareholder dangers must direct their thoughts to form 14-A. Don't be afraid to pay up for management that delivers results for shareholders, but when the rewards go only to the top, and come no matter how badly the company performs, it's time to get out.
The Fool is strong with these related takes:
- Bill Mann had Krispy Kreme's number a while back, and he still thinks the taste is not so good.
- Come to think of it, he had AIG's number, too.
- The office Yoda explains why earnings don't matter if they're not used well.
- Hollinger International offers good lessons from looters.
Bernie was bad, but WorldCom was a good investment once it was reborn as MCI. Philip Durell snared his Inside Value investors a 40% gain on the shares in only six months. Inside Value is on sale now, and a free trial will let you see what's on the radar these days.
Seth Jayson is willing to take his pay in frozen Han Solos or Tauntaun saddles. At the time of publication, he had positions in no firm mentioned. View his stock holdings and Fool profile here. Fool rules are here.
