There is a huge element of “unknowns” in investing. A business is a highly complex organism that is evolving and changing each day, not to mention that the environment and its competitors are doing the same each day, sometimes at an alarming rate.
These unknowns force a passive investor to place a massive amount of trust in the people running a business, recognizing that there is a limit to the amount of diligence that can be done.
However, there is certainly a long trail of breadcrumbs that can be identified when dealing with management.
Let’s start in my daughter’s bedroom. Often, I find myself telling her to clean her room.
The other day, she said she picked up 10 items of clothing. I subsequently visited her room and found about 40 items of clothing still on the floor. Her statement was true…objectively speaking….
As for those 10 items, I found them stuffed in her first dresser drawer.
Most companies put out two documents every quarter. First, a 10-Q, which is required by the SEC. This is a highly formatted document, which includes financial statements and notes.
Second, companies typically release some sort of press release regarding their earnings. This second document is much more subjective and gives management an opportunity to tell their version of events.
In my daughter’s case, the 10-Q would have been my personal inspection of the room discovering the 40 items of clothes still on the floor and the other 10 items stuffed in the dresser drawer.
Her press release, however, would have announced, “New daily record of 10 items were picked up and put away, a 10-fold increase from the day before!!”
There are layers to truth in these statements and the comparison between the press release and the quarterly reports allows you to not only gauge the truth for yourself, it allows you, more importantly, to judge how honest management is being in their communications. If my daughter is shading the truth about picking up her clothes, should I double check her claims about brushing her teeth and doing her homework?
When investing in a public company, you should always double check claims from management, but if the double checking proves that management is taking liberties with their portrayal of the objective truths, you should start to question where else they might be hiding the ball. And if you find yourself having to question them too often, they might not be the best investment partners.
What originally got me thinking about this idea was the recent press release of WIX. WIX is a fairly new company, 13 years old, to be exact. WIX helps their customers design and host websites. Included in their most recent press release was the following statement:
|Expected future collections of existing user cohorts over the next 8 years increased to $6.1 billion, up 24% Y/Y|
Did I read that correctly? WIX is projecting revenue for the next 8 years from their current customers? Oddly enough, I have two things in common with this statement. I recently cancelled two websites I did with WIX last year, so I think I was part of that existing user cohert, but certainly will not be there in 8 years. Secondly, my daughter in the above story is 13 years old and I put a low degree of confidence in her projections for 8 years into the future. In fact, probably about the same level of confidence I have in WIX’s statements.