Be brave, and patient, to make a fortune in value investing

March 26, 2014 8:23 am

Be brave, and patient, to make a fortune in value investing

By John Authers

Combining two popular approaches will reward stockpickers

Fortune favours the brave. And everything comes to he who waits. In these two well-worn phrases lie differing justifications for two different approaches to value investing. Both have merit, but the trick is to combine them. Read more of this post

Dividends And Buybacks: Practical Differences, By Michael Mauboussin

Dividends And Buybacks: Practical Differences, By Michael Mauboussin

by VW StaffMarch 24, 2014, 3:36 pm

Michael Mauboussin piece…. Michael Mauboussin has authored books, Think Twice: Harnessing the Power of Counterintuition and More More Than You Know: Finding Financial Wisdom in Unconventional Places. Read more of this post

Prof. Sanjay Bakshi: On Moats And Value

Prof. Sanjay Bakshi: On Moats And Value

by VW StaffMarch 24, 2014, 4:45 pm

Safal Niveshak: Let me start with a question I have been waiting to ask you for some time now. Through a comment on a link I shared on Facebook and through a few of your posts over the past few months, you have suggested that your investment philosophy has moved further towards high quality businesses, and great managements. Can you please elaborate on the same? What has been this transition all about? And why? Read more of this post

Evasive Shareholder Meetings

Evasive Shareholder Meetings

Yuanzhi Li, David Yermack

NBER Working Paper No. 19991
Issued in March 2014
We study the location and timing of annual shareholder meetings. When companies move their annual meetings a great distance from headquarters, they tend to announce disappointing earnings results and experience pronounced stock market underperformance in the months after the meeting. Companies appear to schedule meetings in remote locations when the managers have private, adverse information about future performance and wish to discourage scrutiny by shareholders, activists, and the media. However, shareholders do not appear to decode this signal, since the disclosure of meeting locations leads to little immediate stock price reaction. We find that voter participation drops when meetings are held at unusual hours, even though most voting is done electronically during a period of weeks before the meeting convenes.

Don’t Believe the Hype: Local Media Slant, Local Advertising, and Firm Value

THE JOURNAL OF FINANCE • VOL. LXVII, NO. 2 • APRIL 2012

Don’t Believe the Hype: Local Media Slant, Local Advertising, and Firm Value

UMIT G. GURUN and ALEXANDER W. BUTLER∗

ABSTRACT

When local media report news about local companies, they use fewer negative words

compared to the same media reporting about nonlocal companies. We document that

one reason for this positive slant is the firms’ local media advertising expenditures.

Abnormal positive local media slant strongly relates to firm equity values. The effect

is stronger for small firms; firms held predominantly by individual investors; and

firms with illiquid or highly volatile stock, low analyst following, or high dispersion of

analyst forecasts. These findings show that news content varies systematically with

the characteristics and conflicts of interest of the source.

When Is a Liability Not a Liability? Textual Analysis, Dictionaries, and 10-Ks

THE JOURNAL OF FINANCE • VOL. LXVI, NO. 1 • FEBRUARY 2011

When Is a Liability Not a Liability? Textual Analysis, Dictionaries, and 10-Ks

TIM LOUGHRAN and BILL MCDONALD∗

ABSTRACT

Previous research uses negative word counts to measure the tone of a text. We show

that word lists developed for other disciplines misclassify common words in financial

text. In a large sample of 10-Ks during 1994 to 2008, almost three-fourths of the words

identified as negative by the widely used Harvard Dictionary are words typically not

considered negative in financial contexts. We develop an alternative negative word

list, along with five other word lists, that better reflect tone in financial text. We link

the word lists to 10-K filing returns, trading volume, return volatility, fraud, material

weakness, and unexpected earnings.

Measuring Readability in Financial Disclosures

Measuring Readability in Financial Disclosures

Tim Loughran 

University of Notre Dame

Bill McDonald 

University of Notre Dame – Mendoza College of Business – Department of Finance
July 16, 2013
Journal of Finance, Forthcoming

Abstract: 
Defining and measuring readability in the context of financial disclosures becomes important with the increasing use of textual analysis and the SEC’s plain English initiative. We propose defining readability as the effective communication of valuation relevant information. The Fog Index — the most commonly applied readability measure — is shown to be poorly specified in financial applications. Of Fog’s two components, one is misspecified and the other is difficult to measure. We report that 10-K document file size provides a simple readability proxy that outperforms the Fog Index, does not require document parsing, facilitates replication, and is correlated with alternative readability constructs.

Using 10-K Text to Gauge Financial Constraints

Using 10-K Text to Gauge Financial Constraints

Andriy Bodnaruk 

University of Notre Dame – Mendoza College of Business

Tim Loughran 

University of Notre Dame

Bill McDonald 

University of Notre Dame – Mendoza College of Business – Department of Finance
November 18, 2013

Abstract: 
Financial constraints — the wedge between the costs of external and internal funds — dictate the relevance of financial structure. We propose a new measure of financial constraints based on qualitative information contained in corporate disclosures. We parse 10-K disclosures filed with the Securities and Exchange Commission (SEC) to measure a document’s tone as indicated by the percentage of negative words. We find that the frequency of negative words exhibits very low correlation with traditional measures of financial constraints such as size and predicts subsequent liquidity events — like dividend cuts or omissions, debt downgrades, and asset growth — better than widely-used financial constraint indexes.

Accounting Variables, Deception and a Bag of Words, Assessing the Tools of Fraud Detection

ACCOUNTING VARIABLES, DECEPTION AND A BAG OF WORDS: ASSESSING THE TOOLS OF FRAUD DETECTION

Lynnette Purda

Queen’s School of Business

Queen’s University

Kingston, Ontario, Canada

(lpurda@business.queensu.ca)

David Skillicorn

School of Computing

Queen’s University

Kingston, Ontario, Canada

(skill@cs.queensu.ca)

Abstract

We develop a data-generated list of words most predictive of fraudulent financial reporting and compare

its success in correctly classifying truthful and fraudulent reports with predictions made by models based

on quantitative financial statement variables and four alternative fixed word lists previously shown to be

associated with fraud. We find that the data-generated list can be a useful complement to alternative

methods, greatly reducing the number of false positives produced by models based on accounting

variables and correctly identifying a higher proportion of frauds than alternative “bag of word” methods.

We study the time series of annual and interim reports of firms eventually accused of fraud and assign a

probability of truthfulness to each using the various word lists. On average, the data-generated word list

shows declines in truthfulness approximately three quarters prior to the actual instance of fraud while

other word lists measuring negative tone and the presence of litigation generate probabilities that decline

by a lesser extent much closer to the event. We find that a word list designed to capture conscious

deception has no predictive power in this setting, consistent with financial reports being written by

multiple individuals, many of whom are likely unaware that misrepresentation is occurring. Our results

contribute not only the development of a new detection tool but also to improving our understanding of

how textual analysis may ultimately contribute to the financial investigators’ toolkit.

The Accidental Internationalists: A Theory of Born Globals

The Accidental Internationalists: A Theory of Born Globals

Jean-François Hennart 

Tilburg University – Center and Faculty of Economics and Business Administration
January 2014
Entrepreneurship Theory and Practice, Vol. 38, Issue 1, pp. 117-135, 2014

Abstract: 
The distinguishing characteristic of international new ventures/born globals (INVs/BGs) is that they have foreign sales from the outset, or very quickly afterward. I argue that this is due to their business model. INVs/BGs sell to spatially dispersed customers distinctive niche products that incur low communication, transportation, and adaptation costs. In contrast to the firms described by the Uppsala model, selling to foreign customers does not require additional time or effort for INVs/BGs. Thus INVs/BGs can be seen as accidental internationalists.

Shouting from the Ivory Tower: A Marketing Approach to Improve Communication of Academic Research to Entrepreneurs

Shouting from the Ivory Tower: A Marketing Approach to Improve Communication of Academic Research to Entrepreneurs

Paul Steffens 

Queensland University of Technology – School of Management

Clinton S. Weeks 

Queensland University of Technology

Per Davidsson 

Queensland University of Technology – Brisbane Graduate School of Business

Lauren Isaak 

Queensland University of Technology
March 2014
Entrepreneurship Theory and Practice, Vol. 38, Issue 2, pp. 399-426, 2014

Abstract: 
Evidence‐based practice in entrepreneurship requires effective communication of research findings. We focus on how research synopses can “promote” research to entrepreneurs. Drawing on marketing communications literature, we examine how message characteristics of research synopses affect their appeal. We demonstrate the utility of conjoint analysis in this context and find message length, media richness, and source credibility to have positive influences. We find mixed support for a hypothesized negative influence of jargon, and for our predictions that participants’ involvement with academic research moderates these effects. Exploratory analyses reveal latent classes of entrepreneurs with differing preferences, particularly for message length and jargon.

Howard Lindzon’s key to investing: “The key to investing in general is not to chase”

Howard Lindzon’s key to investing
BY CARMEL DEAMICIS
ON MARCH 20, 2014
If you’re going to take stock market investing tips from anyone in the tech world, Lindzon might be the guy. He’s a Wall Street fanatic who runs a hedge fund and founded two companies in finance — one that was a business news satire show, and the other that is a Twitter-like platform for dishing on the stock market. Read more of this post

A Pension Fund Invests Against the Rules, and Wins; While some call its strategy crazy, the Tampa firefighters and police officers pension fund has benefited from ignoring widely embraced investment doctrine

A Pension Fund Invests Against the Rules, and Wins
MARCH 21, 2014

For decades, Harold J. Bowen III has managed the Tampa firefighters and police officers pension fund to all but unheard-of returns. CreditTami Chappell for The New York Times
By JAMES B. STEWART

Are the trustees of the Tampa firefighters and police officers pension fund out of their minds?
“Quite a few people tell me we’re crazy,” Richard Griner, a 41-year-old Tampa police detective and vice chairman of the pension fund’s board, told me this week. “I go to quite a few investment conferences. They just can’t believe that we do this the way we do. But then I tell them the numbers, and they tend to shut up.” Read more of this post

Value Investing, the Sanjay Bakshi Way 2.0

Value Investing, the Sanjay Bakshi Way 2.0 – Part 1
POSTED ON MARCH 18, 2014 // 15 COMMENTS
After much delay owing to issues in getting mutually convenient dates, I have finally finished my interview of Prof. Sanjay Bakshi.
Here is the first part of the interview. As you will find below, it’s amazing the way Prof. Bakshi has explained critical concepts in investing in a highly comprehensive yet simplified manner. Read more of this post

How Cliff Asness Launched AQR; AQR’s Value Strategies In Practice

How Cliff Asness Launched AQR; AQR’s Value Strategies In Practice
March 18, 2014 by Tobias Carlisle
Institutional Investor has a great piece from Clifford Asness and John Liew called The Great Divide over Market Efficiency on the efficient markets debate. Most interesting for me was their discussion on the launch of AQR and the “value” strategies it employs:

Read more of this post

How Investors May Be Getting Fooled by Buybacks

How Investors May Be Getting Fooled by Buybacks

NEW YORK March 11, 2014 (AP)

By BERNARD CONDON AP Business Writer

If you’re puzzled why the U.S. stock market has risen so fast in a slow-growing economy, consider one of its star performers: DirecTV. Read more of this post

Blockholder Exit Threats and Financial Reporting Quality

Blockholder Exit Threats and Financial Reporting Quality

Yiwei Dou 

New York University (NYU) – Department of Accounting, Taxation & Business Law

Ole-Kristian Hope 

University of Toronto – Rotman School of Management

Wayne B. Thomas 

University of Oklahoma – Michael F. Price College of Business

Youli Zou 

George Washington University – Department of Accountancy
January 4, 2014
Rotman School of Management Working Paper No. 2374770

Abstract: 
Recent theoretical and empirical studies suggest that blockholders (shareholders with ownership ≥ 5%) exert governance through the threat of exit. These shareholders have strong incentives to gather private information and sell their shares when managers are perceived to underperform. To prevent blockholders from selling their shares and the firm from suffering a stock price decline, managers align their actions with the interests of shareholders. As a result, these managers are expected to have fewer incentives to conceal their activities and are less likely to manage earnings. Consistent with these predictions from economic theory, we find evidence that as exit threat increases, firms have higher financial reporting quality. Furthermore, the impact of blockholders’ exit threat on financial reporting quality increases as the manager’s wealth is tied more closely to the stock price. Our study contributes to the research on the impact of shareholders on financial reporting quality and to an emerging literature on the impact of blockholders in financial markets. Blockholders play an important role in managers’ reporting outcomes through their actions as informed investors.

Beware Of Earnings Gimmicks by Columbia Management

March 10, 2014, 1:00 pm

Beware Of Earnings Gimmicks by Columbia Management

Since the global financial crisis, economic recovery worldwide has been slow. Over the last three years, annual gross domestic product (GDP) growth in the U.S. was limited to 2.1%, significantly below its long-term average of 3.3%. In this low growth environment, for a majority of companies, churning out high earnings-per-share (EPS) growth rates, either through top-line growth or margin expansion, has become increasingly more difficult. At the same time, the markets are at all-time highs, with multiple-expansion driving most of the rally. Expectations are high and everyday investors and Wall Street analysts alike have adopted a “show me” attitude. The consequence for a disappointing report could be severe. To appease Wall Street, corporate managements are pressured to do everything in their power to deliver strong earnings numbers. There are a wide range of possible accounting gimmicks that could be deployed. Some examples are premature recognition of revenue, aggressive capitalization of expenses, exaggerating current expenses/losses to create cookie jar reserves, classifying one-time gains as earnings from continuing operations and hiding debt in unconsolidated subsidiaries. Read more of this post

Preparing for a Succession Emergency: Learning from Unexpected CEO Departures

Preparing for a Succession Emergency: Learning from Unexpected CEO Departures

Jason D. Schloetzer 

Georgetown University – McDonough School of Business

Edward Ferris 

Milano School of Management and Urban Policy
The Conference Board Director Notes No. DN-V5N3, February 2013
Georgetown McDonough School of Business Research Paper

Abstract: 
Succession planning is one of a board’s most important oversight responsibilities. Accordingly, a majority of corporate boards conduct an annual review of the CEO succession planning process. However, emergency succession events, such as the unexpected departure or sudden death of a CEO, act as a “stress test” of the succession process and place considerable pressure on boards to act swiftly and decisively to fill the leadership gap. A quick response can be problematic if the succession planning process lacks an emergency component or a succession-ready candidate is unavailable. This report outlines common issues that arise during an emergency succession, provides guidance on how to prepare for and respond to a succession crisis, and encourages boards to integrate succession planning into the company’s crisis-preparedness process.

Financial Statement Irregularities: Evidence from the Distributional Properties of Financial Statement Numbers

Financial Statement Irregularities: Evidence from the Distributional Properties of Financial Statement Numbers

Dan Amiram 

Columbia Business School – Accounting, Business Law & Taxation

Zahn Bozanic 

Ohio State University (OSU) – Department of Accounting & Management Information Systems

Ethan Rouen 

Columbia Business School
January 2, 2014
Columbia Business School Research Paper No. 14-9

Abstract: 
Anecdotal evidence suggests that a significant portion of financial statement irregularities are ignored or missed by reporting firms, their auditors, and the SEC. Motivated by a method used by forensic investigators and auditors to detect irregularities in a variety of settings, we create a composite, red flag financial statement measure to estimate the degree of financial reporting irregularities for a given firm-year. The measure, which has several significant conceptual and statistical advantages over available alternatives, assesses the extent to which features of the distribution of a firm’s financial statement numbers diverge from a theoretical distribution posited by Benford’s Law, or the law of first digits. We find that whether in aggregate, by year, or by industry, the empirical distribution of the numbers in firms’ financial reports generally conform to the theoretical distribution specified by Benford’s Law. In a battery of construct validity tests, we show that i) manipulating revenue for a typical conforming firm will induce an increase in the deviation from the theoretical distribution 87% of the time, ii) the divergence measure is positively correlated with commonly used earnings management proxies, iii) the restated financial reports of misstating firms exhibit greater conformity, and iv) divergence decreases in the years following restatements. Turning to the informational implications of Benford’s Law, we provide evidence that as divergence increases, information asymmetry increases and earnings persistence decreases in the year following the disclosure of the financial report. Finally, we show that our measure predicts SEC Accounting and Auditing Enforcement Releases. Compared to firms that were not caught committing fraud by the SEC, firms that were caught have a higher deviation from Benford’s Law three years prior to fraud detection. However, while firms that were not caught are able to maintain a constant level of deviation, firms that were caught appear to have a significant decline in their deviation from Benford’s Law in the years before they were caught. The results are consistent with the explanation that fraudulent firms are able to hide their activities using techniques that violate Benford’s Law, but only get caught if those techniques become unsustainable.

Opting Out of Good Governance

Opting Out of Good Governance

C. Fritz Foley, Paul Goldsmith-Pinkham, Jonathan Greenstein, Eric Zwick

NBER Working Paper No. 19953
Issued in March 2014
Cross-listing on a U.S. exchange does not bond foreign firms to follow the corporate governance rules of that exchange. Hand-collected data show that 80% of cross-listed firms opt out of at least one exchange governance rule, instead committing to observe the rules of their home country. Relative to firms that comply, firms that opt out have weaker governance practices in that they have a smaller share of independent directors. The decision to opt out reflects the relative costs and benefits of doing so. Cross-listed firms opt out more when coming from countries with weak corporate governance rules, but if firms based in such countries are growing and have a need for external finance, they are more likely to comply. Finally, opting out affects the value of cash holdings. For cross-listed firms based in countries with weak governance rules, a dollar of cash held inside the firm is worth $1.52 if the firm fully complies with U.S. exchange rules but just $0.32 if it is non-compliant.

On Finding Neglected Companies

On Finding Neglected Companies

David J. Merkel

While at RealMoney, I wrote a short series on data-mining.  Copies of the articles are here: (one, two). I enjoyed writing them, and the most pleasant surprise was the favorable email from readers and fellow columnists. As a follow up, on April 13^th, 2005, I wrote an article on analyst coverage — and neglect. Today, I am writing the same article but as of today, with even more detail, and comparisons to prior analyses. Read more of this post

‘Deep value’ vs. ‘high quality’: Berkshire numbers rekindle debate

‘Deep value’ vs. ‘high quality’: Berkshire numbers rekindle debate 

R.B. MATTHEWS

Special to The Globe and Mail

Published Monday, Mar. 03 2014, 7:40 PM EST

Last updated Monday, Mar. 03 2014, 7:45 PM EST

R.B. (Biff) Matthews is chairman of Longview Asset Management Ltd.

Warren Buffett’s recent annual letter to shareholders reveals that, over the past five years, the increase in Berkshire Hathaway Inc.’s book value was less than the investment return provided by the S&P 500 index. This has rekindled a long-standing debate between two schools of value investors. Read more of this post

Learning From the Doers: Developing Country Lessons for Advanced Economy Growth

Learning From the Doers: Developing Country Lessons for Advanced Economy Growth

Anusha Chari, Peter Blair Henry

NBER Working Paper No. 19934
Issued in February 2014
From 1980 to 1992, emerging and developing countries grew by 3.4 percent per year. Their annual rate of growth increased to 5.4 percent between 1993 and 2012. No such increase occurred for advanced nations, whose average growth from 1980-2012 was roughly constant (excluding the impact of the 2008-09 Recession). Developing nations turned themselves around by embracing discipline—sustained commitment to a pragmatic and flexible growth strategy. Three illustrations of discipline through the lens of trade, fiscal, and debt reforms in the developing world offer relevant, practical lessons for recovery in advanced economies and continued catch-up growth in developing nations.

Buffett loses $900m by not consulting partner Munger; Billionaire investor admits he made a “big mistake” in spending $2bn to buy EHF debt without asking for the opinion of his long-serving collaborator Charlie Munger

Buffett loses £537m by not consulting partner

Billionaire investor admits he made a “big mistake” in spending $2bn to buy EHF debt without asking for the opinion of his long-serving collaborator Charlie Munger

In his annual letter to Berkshire Hathaway shareholders published at the weekend, Mr Buffett said he wished he had “never heard” of Energy Future Holdings (EHF) Photo: REUTERS Read more of this post

Are Seemingly Self-Serving Attributions in Earnings Press Releases Plausible? Empirical Evidence

Are Seemingly Self-Serving Attributions in Earnings Press Releases Plausible? Empirical Evidence

Michael D. Kimbrough 

University of Maryland – Robert H. Smith School of Business

Isabel Yanyan Wang 

Michigan State University
July 24, 2013
Accounting Review, Forthcoming

Abstract: 
Seemingly self-serving attributions either attribute favorable performance to internal causes (enhancing attributions) or poor performance to external causes (defensive attributions). Managers presumably provide such attributions in earnings press releases to heighten (dampen) investors’ perceptions of the persistence of good (bad) earnings news, thereby increasing (decreasing) the market reward (penalty) for good (bad) earnings news. Building on attribution theory and prior research on earnings commonality, this study investigates cross-sectional differences in investors’ responses to quarterly earnings press releases that contain seemingly self-serving attributions. Using a random sample of press releases from 1999 to 2005, we find that firms that provide defensive attributions to explain earnings disappointments experience less severe market penalties when: 1) more of the their industry peers also release bad news, and 2) their earnings shares higher commonality with industry- and market-level earnings. On the other hand, firms that provide enhancing attributions to explain good earnings news reap greater market rewards when: 1) more of their industry peers release bad news, and 2) their earnings shares lower commonality with industry- and market-level earnings. Collectively, our results demonstrate that investors neither ignore seemingly self-serving attributions nor accept them at face value, but rely on industry- and firm-specific information to assess their plausibility.

Warren Buffett’s 2013 annual letter to Berkshire Hathaway shareholders is out. The ‘Mother Lode’ Of Investing Opportunities Is Right Here In America

WARREN BUFFETT: The ‘Mother Lode’ Of Investing Opportunities Is Right Here In America

SAM RO MARKETS  MAR. 1, 2014, 9:31 PM

In his just-released annual letter to Berkshire Hathaway shareholders, Warren Buffett updates us on his merger and acquisition activity. Read more of this post

Pork Bellies and Public Company Audits: Have Audits Once Again Become Just Another Commodity?

Pork Bellies and Public Company Audits: Have Audits Once Again Become Just Another Commodity?

Brant E. Christensen 

Texas A&M University – Department of Accounting

Thomas C. Omer 

University of Nebraska at Lincoln – School of Accountancy

Nathan Y. Sharp 

Texas A&M University – Department of Accounting

Marjorie K. Shelley 

University of Nebraska at Lincoln – School of Accountancy
October 8, 2013

Abstract: 
Prior research has established that from 2000 to 2007, auditors recognized clients’ financial reporting risk and incorporated that risk into their audit fees (Charles et al. 2010; Doogar et al. 2010, 2012). However, regulators have expressed concerns about the impact of the subsequent economic downturn and resulting fee pressure on auditor effort. We provide evidence of a marked decline in auditors’ pricing of financial reporting risk during the 2006-2010 period, suggesting auditors have been unable to sustain their focus on the risk of misreporting in recent years. This decline is particularly evident among non-industry expert auditors. Additionally, we find higher rates of financial statement restatements among high-risk clients where their risk appears not to be incorporated in audit fees. Our results are consistent with a return to the commoditization of financial statement audits and its negative impact on audit quality.

Does the Capital Market Punish Managerial Myopia?

Does the Capital Market Punish Managerial Myopia?

Jamie Tong 

University of Western Australia; Financial Research Network (FIRN)

Feida Zhang 

Murdoch University – School of Business
February 14, 2014
FIRN Research Paper

Abstract: 
The extant literature provides conflicting arguments on whether the capital market punishes managers’ myopic behavior. Stein (1988, 1989) argues that the capital market is myopic and will push managers to behave myopically. In contrast, Jensen (1988) believes that the capital market is efficient and will punish managerial myopia. However, empirical studies on how the stock market reacts to managerial myopia are scarce. This study aims to fill in this gap by examining how the capital market reacts to managerial myopia. Using managers’ cutting R&D to meet short-term earnings goals as a research setting, this study reveals that the capital market actually penalizes managerial myopia, especially for firms with high investor sophistication. Our results are consistent with Jensen’s (1988) contention that the security market is not shortsighted. Additionally, we document that compensation, especially cash compensation, could be one of the reasons why managers behave myopically.

Investing in the Unknown and Unknowable