Restating Earnings
First off, I don’t own DELL stock or their computers. (Frugal girls like me go with cheap $400 generic boxes!) Second, I work for an accounting and finance team at work and helping the accounting team go over the numbers is part of my job.
Apparently Dell has stopped trading on the stock market because they are going to restate their earnings back to 2003. WHOA NELLY. That’s a long time.
Normally I don’t post about individual stocks, but I think this is really noteworthy to mention here for nascent stock investors. What does a restatement of earnings really mean?
1) It means that some auditors went through the books with a fine-toothed comb, thus incurring some serious audit expenses for the company.
2) It means that the company’s past performance may not have been as rosy as reported.
3) It means that they were probably not following FASB, the financial accounting standards that US CPA’s are expected to follow when doing accounting. This isn’t necessarily a horrible Enron-cooking-books scenario though. It may mean that they misinterpreted a few rules and are fixing the error. But it does means they should have had better guidance from their auditors since they’re paying so much for them, see #1.
4) What does guidance from auditors mean? It means that every year, a publicly traded firm puts out 4 audited financial statements and files them with the SEC. When an audit takes place, an audit firm (think PricewaterhouseCoopers, KPMG, Andersen, Deloitte, et al) will review the accounting practices of the firm and tell them what they are doing right and wrong and guide them in fixing their practices.
Why does all this matter? It matters because when you look at a company and begin your own research into whether or not it is a good investment, you are reading their audited financial statements. Therefore you are relying on them to give an accurate picture of the company’s health. Think of it this way, if a smoker goes into the doctor’s office and says I have a terrible cough, but doesn’t tell the doctor they smoke 2 packs a day, the doctor may think that the cough is from a simple bronchial infection and prescribe an antibiotic, when in actuality the patient has emphysema and needs an oxygen tank.
Accurate information is key in assessing a company’s proper market valuation. When those financial statements have to be restated for several years, that can make a serious difference in the company’s valuation.
Madame X at My Open Wallet pointed out a great article in the NYT about valuation by Graham and Dodd (the textbook writers on Value Investing, i.e. Warren Buffett’s style of investing). In the article, it says that Graham and Dodd advocated looking at P/E over 7 years, not just the trailing twelve months (aka ‘ttm’). If Dell is restating their earnings for 4 years, that could throw a 7 year valuation number seriously out of whack. It means it’s a systemic issue that had to be rooted out with some major research work. Food for thought. It’s not necessarily a horrible thing, as I said before, but it does mean that the guidance the company received over the last few years was lacking. I actually smell a lawsuit with the audit firm…
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