Not Counting (Part 3)

So if the numbers don’t count, how do you invest?

After all, stocks and bonds depend on a company’s ability to generate cash to pay interest and dividends and grow its business. The financial statements are the report card, and accountants are supposed to tell you how reliable that report card is. If you can’t trust the statements, how do you put your money to work?

One way is to use index funds to invest in an entire economy. Most people are basically honest, even in a crooked system, and the law of large numbers says that if you invest in thousands of companies, the inevitable accounting errors will cancel each other out and the average price will be fair—except when we go collectively insane, like we did during the internet and housing bubbles and the subsequent bust.

Another way is to find solid companies that even a crook would find it hard to steal from: firms in competitive businesses that pay reasonably high and growing dividends. Managers can fudge a lot of numbers, but they can’t lie about the cash they give you. That kind of discipline makes it hard for accountants to get too creative. As a side-benefit, narrow margins are less attractive to the looter-set than cash-cows.

By investing in everything and also in specific, transparent enterprises, you have a reasonable chance of getting your money back. Even if the accounting doesn’t count.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

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