How to Invest In Integrity

A curious item caught my eye this morning. Shares of Inverness Medical (NYSE: IMA) are off nearly -20% after management lowered earnings guidance at an investment conference. I checked out their 8-K or any press release that would help explain why this medical diagnostics firm is seeing a tougher profit environment. After all, that could clue you in on any factors that might be impacting rivals as well.

But Inverness never bothered to alert the general public – even though it is required to do so. Some investors profited from the news, but the rest of us missed it. And that's not right. After the dot-com bubble, companies were chastised for selectively releasing information, and those that did faced major fines. But as time has passed, the SEC seems less concerned, and an increasing number of companies are talking out of school.

For individual investors, the lesson is quite clear. Never ever invest in a company that cannot be forthright with all of its investors. You may be tempted to buy shares of Inverness now that they are far cheaper, but how will you know if management will once again share information only with their closest investors? Inverness may claim that the comments were made in a public forum, but chances are, neither you nor I would have gained entry to the forum.

Here are some other issues that should always give investors pause:

  • Perpetually changing guidance. New York & Co. (NYSE: NWY) stunned investors by noting that results in the second quarter would be weak. Two weeks later, they said it’s even worse than they thought. Nothing much changed in those two weeks, expect that management took a long time getting their hands around their sales problems. If you can’t trust a company’s ability to stay on top of their sales trends, you shouldn’t own its stock.
  • One-time charges. This has been discussed many times in investor circles, but bears repeating. If a company gives you two sets of numbers every quarter – one for how sales and profits would have fared without special charges or gains, and one prepared according to GAAP that includes those charges and gains – it's probably a sign that they are spinmeisters. Companies have a lot of leeway with their accounting decisions, and liberally sprinkle in gains and charges to massage and finesse their results. If "one-time" events happen over and over, they are a normal part of doing business.
  • "Temporarily" falling margins. Companies will often cite short-term factors as to why profit margins are under pressure. But you should know that profit pressures are rarely short-term in nature. They usually signal tougher competition or weakening demand, and there's no quick fix for either of those. The best investments always involve companies that have a clearly articulated path to rising profit margins. That's a sign that newer products are selling well or management has found way to achieve operating efficiencies.
  • Buy backs that aren't.  Many companies like to tout their stock buy back plans, but in almost half of all cases, the total share count fails to shrink. Instead, buy backs simply offset the massive stock options being doled out to executives. If a buy back has been in place for several quarters, shares outstanding should be falling materially.

Action to Take --> Any time you are just getting up to speed with a new investment idea, keep an eye out for these red flags. If you've been burned once, chances are you'll be burned again.

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