When something exceptional happens twice, we call it coincidence. When it happens a third time, we suspect a trend.
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When it happens repeatedly, we adjust to a new reality.
It’s a wonder, then, that we’re stunned by the latest big corporate accounting scandal: WorldCom Inc.’s disclosure that it cooked its books for five straight quarters, pulling off a massive $3.8 billion fraud.
Bookkeeping scandals are as old as the abacus, but we’re not used to big ones coming on the heels of one another, just when we were looking for a stock market recovery.
Get used to it.
There’s a reason our accounting messes have been concentrated in telecommunications and energy–two of the fastest-growing sectors during the 1990s stock boom.
There were heady incentives for executives with option-laden pay packages to hatch schemes to make it seem as though their companies’ good times would last forever.
But accounting chicanery unravels when the economy turns south.
Eventually, investors sober up. Regulators and criminal investigators dig in and politicians jump onto their bully pulpits. Truth comes out.
Among the recent confessors are bankrupt cable operator Adelphia Communications Corp., a target of criminal and regulatory probes, which concedes it falsely inflated its profits for 2000 and 2001.
Still protesting innocence are Qwest Communications International Inc. and Global Crossing Ltd., both under investigation of questionable accounting related to buying and selling network capacity.
In the energy sector, there’s the fallen giant–Enron Corp.–as well as an investigation of Dynegy Inc.
Gary Brinson, a well-known value investor and retired money manager, can’t recall a time during his career of more than 30 years when there were so many big accounting scandals. But he wouldn’t be surprised to see more, and he’s not worried about investors’ shaken confidence.
When investors lose hope, people like Brinson take heart. He sees investor despair as evidence we’re entering the final phase before a stock market recovery, when we kill off all the unrealistic hopes and dreams we nurtured during a boom.
Sound brutal? It is. But then the ’90s were an extraordinary decade, a time when investors came to believe that double- and triple-digit returns were their right in a tech-driven economy of limitless growth.
The headiest of growth stocks, the dot-coms, were straightforward about their prospects. They laid it out in plain red ink in their prospectuses: They planned to freely spend investors’ money without saying when, if ever, they would return a dime.
When they began failing in droves, conservative investors comforted themselves with the knowledge they had put their money with the big corporate gang.
False comfort.
Corporate executives and their accountants were rewarded for financial reports that perpetuated the fiction of unbridled growth.
Bad accounting can run the gamut from criminally fraudulent misstatements to perfectly legal reporting that stretches the envelope, making results look better than they might otherwise. Both fraud and gimmickry abounded during the ’90s.
Brinson sees the string of accounting scandals and the stock market’s lousy performance as perverse good news.
After all, scandals stiffen auditors’ backs and set the stage for more conservative accounting.
As for returns, Brinson thinks they’re nearly where they ought to be–finally.
By his calculations based on cash flow analysis, the S&P 500 is getting close to a level where an investor could expect a “satisfactory” return.
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What’s satisfactory? Try 7.5 percent, about 5 percent inflation-adjusted.
“People shouldn’t view that as some sort of demoralizing return,” says Brinson, who still holds short positions in tech and telecom stocks.
A scandal du jour and 7.5 percent returns? That doesn’t sound like anything to celebrate.
Get used to it.
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