Accounting issues scare the bejesus out of investors.
Hertz Global Holdings (HTZ) filed an 8-K with the SEC Friday that could throw into jeopardy the veracity of its financial statements for 2011, 2012 and 2013. The news has HTZ stock down on heavy volume.
For those of you that own HTZ stock … my condolences.
These things always take time to resolve themselves and until they do, your stock is twisting in the wind. There’s not much you can do except ride out the storm. Only after the audit committee conducts a thorough review, reports its findings and then makes the necessary restatements will investors understand the full ramifications of the accounting issues that caused the review in the first place.
Some will be tempted to cut and run. After all, this isn’t the first news of Hertz’s accounting issues. In March it announced $46.3 million in reporting errors from 2011. Two months later, it delayed releasing its Q1 results based on its findings about those errors; now it’s found more accounting issues.
The first set of problems appear to have done little to dampen investor enthusiasm for HTZ stock. What happens next is anyone’s guess. The audit committee could find major accounting issues that throw into question everything about its business … or it might determine that they aren’t much of anything.
If you think the other shoe is going to fall, then it’s pretty clear you need to sell your HTZ stock … immediately. If, on the other hand, you believe in management and the business itself — including the much-anticipated separation of its equipment rental operation — then you might want to take this opportunity to buy on the uncertainty. Doing so during a correction (big or small) isn’t for the faint of heart, but it can lead to oversized profits if it works.
And finally, there’s a third option, which might be the best decision: doing nothing.
Accounting Issues — A Teachable Moment
Anyone who’s invested long enough has been through a scrape or two when it comes to accounting snafus. I once invested (back in 2001) in ACLN Ltd., a company that shipped new and used cars to Africa. Herb Greenberg was highly skeptical of its business and financial statements. ACLN turned out to be a fraud, and I lost a decent amount of money in the process.
ACLN taught me that, if the accounting sounds too good to be true, it probably is.
That’s not what’s happening at Hertz, but it does underscore the importance of fully understanding your investments. No, I’m not suggesting that you get your CGA or CFA … but at least have a decent grasp of the financial underpinnings that support the value of your stocks.
If you can’t do that, you should listen to Warren Buffett and buy a good index fund that mimics the S&P 500.
Accounting Issues — A Case Study
One of the best recent examples of what can happen to a company’s stock (and business) when rocked by an accounting scandal is Diamond Foods (DMND), the California snack food company whose 2012 internal audit found $80 million in payments to walnut growers were improperly accounted for.
Ultimately, it was forced to restate its 2010 and 2011 earnings (went from profit to loss), its CEO and CFO were replaced, it settled a $96 million settlement with investors, its $2.5 billion acquisition of Pringles from Procter & Gamble (PG) was scuttled … and in early January of this year, it settled ($5 million paid to SEC with no admission of guilt) charges with the SEC that it falsified costs to boost its earnings.
The important question: How’d DMND stock do through all this?
The accounting issues first came to light in a September 25, 2011, report by Mark Roberts of the Off Wall Street Consulting Group, Inc. In it he revealed that Diamond Foods’ gross margin was about five percentage points too high as a result of a momentum payment made to walnut growers that should have counted against its July 2011 fiscal year but instead was entered into its next fiscal year making its profit that much higher.
Just days before the report came out DMND stock was trading as high as $96.13. Once the accounting issues hit the street, it was a quick ride down to $32 by the end of 2011. One year later, its stock had declined to below $15 where it bottomed. Now trading around $30, DMND stock is trying to regain momentum lost. Although yesterday’s Q3 2014 earnings release has the stock down in Friday trading, its snack business appears to be strong and the worst seems to be behind it.
Where there’s smoke there’s fire. Diamond Foods’ ordeal lasted more than two years, and in some respects is still hanging around (as its Q3 results attest). Hertz’s problems aren’t going to quickly go away, which means HTZ stock will remain under pressure for some time.
Are its accounting issues similar to Diamond Foods? No, they’re not.
In Diamond’s case you are talking about executive officers knowingly altering the company’s profit picture in order to benefit (Pringles acquisition was to be paid in DMND stock). While no one has actually gone to jail, but the people in charger weren’t far away from doing time.
Hertz’s accounting issues appear to be due to lax accounting controls and nothing of a nefarious nature. Therefore, if you are a fan of its business I’d be tempted to buy some more on weakness. From where I sit, it doesn’t appear to be anything too damaging … but I’ve learned from the school of hard knocks never to say never.
As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.