A couple of weeks ago an interesting article was posted on Stockopedia:
‘Dividends are more reliable than accounts’
This is a pretty bold statement and, having ruminated on it a bit, one I can’t help but disagree with. I started typing a comment by way of response on there, but having got a bit long, I figured I’d move it over here with a suitably gauntlet-laying title. My teachers always did say I was prone to exaggeration! Click through and read the article for yourself if you want to get it from the horse’s hooves, but I’ll attempt to summarise the author’s argument here as fairly as I can:
Active management is bad because it’s difficult to spot profit warnings coming, and difficult to discern future profitability. It is better to base investment decisions on a ‘fundamental measure, like dividends’.
On unreliability
The charge that accounts are unreliable is one that comes up quite often. I note one thing to start with; if you like investing in AIM-listed Chinese companies, or exciting little oil & gas plays, I sympathise with you – you might well find published accounts a decidedly questionable source of information.
On Tesco, though, I think the furore about the profits overstatement is the exception that proves the rule. Everyone knows that companies are flexible beasts and accounting is a science of best guesses and justified assumptions – but the proverbial ton of bricks that has been brought down on Tesco’s head says a lot about the view the market takes when the accounts lose their sanctity. In some senses, Tesco’s predicament was probably more likely than in most FTSE companies. Where does one expect the pressure to overstate profits is most prevalent? Perhaps in a company which has been battered by market forces and has lost its do-no-wrong halo in the last few years? This is to say nothing about the incentives of other participants to investigate given Tesco’s particular situation…
In most cases, markets make their views on fishy accounts quite clear – you only have to look at Quindell to see that much. The market is suspicious. You cannot avoid it. Sometimes, something really does come out from the blue – but such is life. A significant number of dodgy accounts post obvious characteristics – cash flow problems, usually, and a little digging into the numbers has a great deal of value. The real surprises on…
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