By Any Other Name …

Do names matter?

Photo: Laitche. Source: Wikimedia

In Romeo and Juliet,Juliet famously questions if a rose would smell just as sweet if we called it something else. And the answer to that is, both yes and no. The fragrance would be the same, of course. But the “sweetness”? That’s purely subjective. It’s based on our experience and expectations, as well as what we might compare it to. In “The Hunger Games” the villain — President Snow — always wears a rose, and he uses roses to remind the heroin, Katness, of his power. The smell of roses becomes nauseating to her.

It’s critical to address things as they really are to call them by their correct names. No one is fooled when a coach calls a losing season, “a building year.” In high school, I had a teacher who called his tests, “learning experiences.” We knew what that meant: lots of studying, if we wanted to pass. So in that way, I suppose he was right. But we sure didn’t look forward to our “experiences” in his class.

In corporate reporting these days there is a movement to use non-GAAP earnings in a company’s regular meetings with Wall Street analysts. They do this to “accentuate the positive”—to focus on what they are doing well, and avoid the bad news. This becomes a game among market participants. Managers, auditors, and analysts play an elaborate charade of nods and winks. Wishful thinking wins the day over faithful representation in a numbers game.

How do they do this? In overstating restructuring charges—throwing the “kitchen sink” into bad news announcements to make the future look better; in “merger magic” where part of an acquisition is labeled “in-process”; in “cookie jar” reserves, where companies stash accruals during good times to smooth things out in the bad times; and by playing games with revenues—recognizing sales before the sale is complete. Companies play these games to meet their budgets. If managers don’t perform according to plan, they might not receive their bonuses, or might even get fired. The list of major accounting scandals is long and detailed. Hundreds of billions of dollars have been lost as a result of willful misstatements.

Source: Pixabay

This reminds me of the Chinese doctrine of Zhèngmíng(), the rectification of names. Confucius noted that if language doesn’t correspond to reality, our social relationships will devolve into chaos. Rulers won’t be able to rule; families will be in discord; friends won’t know who their friends are. Confusion reigns. Ironically, Confucius and Shakespeare end up at the same place. When Romeo and Juliet try to ignore their family history and call a rose something else, friends kill friends, and deceivers are themselves deceived.

It’s critical for investors and analysts to find reality behind the accounting statements. This means they have to go past traditional ratio analysis and examine footnotes, read management’s discussion, and question whether incentives are in line with investor objectives.

A rose is a rose, and earnings are earnings. But if they come from the wrong place, they’re not sweet at all.

Douglas R. Tengdin, CFA

Chief Investment Officer

By | 2017-07-17T12:22:05+00:00 April 11th, 2016|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. –
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