The 3 Dirtiest Words in Investing

These three abused terms could be hiding some red flags

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Don’t you love some of the accounting vernacular (I guess we’ll call it that) getting thrown around these days?

Gone are the times when a company’s bottom line was actually — you know — the company’s bottom line. You have to be a CPA to figure out how well a corporation is doing anymore (and considering the number of accounting-level scandals we’ve seen over the past few years, even “CPA” might be a worthless designation).

The good news is this: The accounting shell game has chosen three terms to use and abuse more than any other. If you can learn what those three really mean, you can decode these dirty words when it matters most.

In no particular order …

1. Non-Cash Charge

On the surface, the words seem benign: “non-cash charge.” Clearly it doesn’t cost anything, since the company doesn’t have to write a check or crack open the vault and take any money out. Don’t think for a minute it’s a mere “paper-only” maneuver, though. A non-cash charge now is usually the reckoning of wasted money in the past (though clearly it wasn’t deemed wasted at the time it was spent). Non-cash charges also are frequently used to account for the expense of stock options granted to company employees.

Owners of Citigroup (NYSE:C) are within a few months of learning how irritating a non-cash charge can be. The mega-bank announced last week it was likely to take a significant non-cash charge in the third quarter to reflect the surprise decrease in the value of its stake in Morgan Stanley Smith Barney — the brokerage firm it jointly owns with Morgan Stanley (NYSE:MS).

Morgan Stanley says the business is worth $9 billion, while Citigroup says it’s worth $22 billion. Considering they both list it as an asset, eventually they’ll have to come up with an agreed-upon number. Anything less than $22 billion means Citigroup’s balance sheet will be a whole lot smaller at the end of the third quarter.

So where’s the harm to shareholders? It actually took place back in 2009 when the deal was first set up. Morgan Stanley threw in $35 billion in funding, and Citigroup — through Smith Barney — threw in $55 billion. Though it’s not like all that cash is just down the drain, the joint venture never has been what it was supposed to be and actually has cost Citigroup revenues and earnings since its inception. Now it’s becoming an official lemon.

Oh, and the non-cash charges for stock option issuance adversely impacts shareholders because it sets up future dilution of earnings.

2. Off-Balance-Sheet Arrangement

In a perfect world, all assets and all liabilities are reflected on a balance sheet. We don’t live in a perfect world, though. And somehow, generally accepted accounting principles (or GAAP) allow companies to omit information that investors would love to know about — and probably deserve to know about — from the balance sheet.


Article printed from InvestorPlace Media, http://investorplace.com/2012/07/the-3-dirtiest-words-in-investing/.

©2014 InvestorPlace Media, LLC

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