Analyst Faults Colleagues for Boosting Enron’s Value
BY MIKE ALLEN
Senior Staff Writer
Enron Corp.’s failure wasn’t caused only by apparent fraudulent accounting and management, but from the negligence of stock analysts, money managers and academics who put too much emphasis on the company’s earnings reports, according to the founder of a New York mutual funds group.
Martin Whitman, the chairman of Third Avenue Funds, said Enron’s management took advantage of an investment approach that still holds sway today; focusing mainly on a firm’s operating earnings while ignoring many other factors that affect a company. Whitman made his remarks at UCSD’s Economics Roundtable Feb. 13.
Whitman pointed to media coverage by CNBC as an example of over-emphasis on earnings, saying the station spends 70 percent of its time discussing whether a company exceeded or did not meet the consensus opinion on quarterly expectations.
“That’s just asking for more Enrons,” he said.
As long as a company’s earnings per share continues growing, as Enron’s did spectacularly during the market run up of the last decade, that type of analysis works fine.
But last year, Enron’s complex business strategy began unraveling. For its third quarter, it revealed it had overstated its profits for past four years by nearly $600 million. Shortly after, as more details of its arcane accounting methods became evident, the stock rapidly sunk below a dollar.
Largest Corporate Collapse
When it filed for bankruptcy protection in December, it was the largest corporate collapse in the nation’s history.
Whitman blamed part of the Enron debacle on those who consider a company’s financial accounting statements as the truth, when the auditors’ report should be viewed as objective benchmarks.
“Nobody with an IQ over 70 expects an accounting statement will tell you the truth,” he said. “It’s not supposed to describe the real world, but to give you a setting to understand the real world.”
Revise Approach
Absent in many analysts’ reviews was a “bottom up” approach to researching companies that looks at the business model and its management to get a clear understanding of what it is, he said.
Whitman’s strategy to investing, called value investing, differs dramatically from the growth approach in vogue in recent years. Value investing puts an emphasis on a company’s balance sheet, and intrinsic value as opposed to how a company’s stock is performing or what industry is hot.
Using this strategy, Whitman’s fund has avoided buying such high fliers as telecom companies, dot-coms, emerging markets, new inventions and new discoveries, as well as Enron.
Good Performance
Third Avenue’s flagship Value Fund may not be exotic, but it has performed admirably. Last year, the fund had a total return of 2.82 percent according to Morningstar.com, a mutual fund rating firm which gave the fund five stars. For the past three years, its average annual return was 10.56 percent and for five years, the average return was 11.13 percent, according to Morningstar.com.
Whitman said another difference from his fund’s strategy compared to the strategies of other fund managers is holding investments for the long term.
“Most of what we invest in has no time horizon,” he said. “If we’re doing it right, the value is always increasing.”
Of course, not everything Whitman touched has turned gold. He admitted his plays in a number of Japanese insurance companies haven’t done well.
On the other hand, his fund has benefited from its investment in Toyota Industries, which he expects to continue growing.
“Toyota has a hell of a shot worldwide of being the Wal-Mart of the automobile industry,” he said.
While the Enron collapse has provoked calls for an overhaul of the auditing industry and regulatory oversight, Whitman is against it.
He says because of Enron, the accounting profession’s reputation has been unjustly sullied.
“The standards of independence and integrity of the audit profession is head and shoulders above anyone else (in the financial services industry),” he said. “Just because of one massive fraud, that’s no reason to make draconian changes to accounting rules.”
