Evaluating Blue Sky

Yesterday, I wrote about the process by which corporate financial information is processed and presented to investors. It was my plan to write about how that process effects the quality of the product. But, it seems more fun to cut to the chase and think about, in light of this process, what financial information should be given investors. (Perhaps later we can chat about the audit process.) The goal here is to evaluate whether it is troubling that most investors could not understand Enron’s financial statements, which is where this discussion began.

Should investors understand the basic financial attributes of a company they invest in? Few car buyers understand modern automotive engineering; yet nobody thinks that this means that there is something wrong with the automotive markets. (Hey, I’m from Detroit: Cars are an analogy to everything.) Individuals can get expert analysis from places like Consumer Reports and JD Power. Reputation and brands provide useful non-technical information about a car. Experience over time drives (pun intended) bad cars out of the market. And so on.

But, cars are not corporate stock. Click for the analysis underlying this surprising conclusion.

Most people do not buy cars primarily to enjoy their engineering. One wants the performance, features, reliability, and the like that comes with good engineering, but most really see the engineering as a means, not as an end. Also, there are non-engineering aspects of car ownership, like style and status. With stocks and bonds, the finances are the heart of the investment. Occasionally one will buy stock for fun, like stock in a sports team or a beer company, but usually one is looking for a financial return, not some other intangible personal benefit.

If you accept this analysis, and I admit it is not overwhelming, financial information is to stock what information about brand, style, color, features and the like is to a car. A rational buyer would not buy without knowing what she is getting.

Which raises two intertwined questions: Is it possible to come up with accountings that investors can understand? If not, what to do? Since the second question goes to what is at stake here, it will be tomorrow’s topic.

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One Response to Evaluating Blue Sky

  1. Barry says:

    Another big difference is that car problems manifest much earlier. Initial problems will be known and publicized in a few months. Long-term reliability/quality is tracked in publicly-available sources (JD Powers, Consumer Reports). With Enron, the problems were well hidden; the supposed ‘honest brokers’ (banks, investment firms) were almost all co-opted, and supported the fraud.

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