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New Constructs Receives Patent on Research System

Thursday, July 22nd, 2010

The United States Patent and Trademark Office awarded us patent #7,752,090, titled: System and Method For Reversing Accounting Distortions and Calculating A True Value of a Business.

This patent is for the automation of the process of

  1. reading and analyzing the entire annual report, including the Financial Footnotes and the Management Discussion & Analysis and
  2. modeling all of that data in a standard and objective manner.

Cash Is a Fact, Earnings Are An Opinion, as Warren Buffett has often said. There is long-standing controversy surrounding the integrity of accounting metrics and companies’ ability to “manage” earnings; there is no controversy surrounding the cash economic profitability of a business as long as the economic model takes into account all relevant information, which our model does as described in Economic Versus Accounting Earnings.

Click for details on 30+ Accounting Adjustments based on key details in the Financial Footnotes and MD&A.

This patent is further evidence of the unique sophistication of our stock investment research. The depth and breadth of New Constructs’ research represents a Paradigm Shift in the quality of equity research. No one gets more data to make more diligent investment ratings than we do.

This patent is for creating a system to do what every good investor (not Speculator) should do. I was more than a little surprised that no one else had already patented this process. I am certainly not the first to propose that equity investors reverse accounting distortions when analyzing stocks. Adam Smith was the first in the 1800′s in Wealth of Nations. However, we are the first to build a system to reverse accounting distortion- which means we are the first to scale what is a VERY time consuming and difficult task to perform manually.

Per my bio, my first job on Wall Street (in 1996) was to figure out how to reverse accounting distortion to build more sophisticated earnings models for Value-based Analysis (VBA), aka Economic Value Added (“EVA”) analysis, for the thousands of companies covered by Credit Suisse. Like my prior job with Arthur Anderson in Houston, my Wall Street job required spending enormous amounts of time reading annual reports and building models. Reversing accounting distortion requires analyzing the Financial Footnotes (“the Notes”) in annual reports, 10Ks, 10K/As, 8-Ks, etc. As a former accountant, I can attest that the Notes are where the most important financial information on companies is often disclosed. Analyzing the Notes requires reading hundred of pages for often obscure details on items like off-balance sheet debt, hidden charges, false revenues, option liabilities, pension liabilities and asset disposals. Every company reports differently, which makes analyzing the Notes even harder. Analyzing the Notes and putting all the data into a model takes a lot of time.  Even after building several hundred models, it still took me at least 1 hour to model a single annual report. I spent thousands of hours reading annual reports because my job depended on my expertise of financial reporting for the 3000+ companies that Credit Suisse covered globally. Reading annual reports for so many different companies around the world taught me a great deal about accounting and finance in a relatively short amount of time.

After I left Credit Suisse, I continued to apply the rigorous form of analysis I had brought to the firm as a more traditional sell-side analyst. While covering only 2 -3 companies, I found it increasingly difficult to do all the work required to understand the true profitability and valuation of companies along with other equity research responsibilities. I had to get faster at reading the annual reports and quarterly reports and modeling the data or I would not be able to meet the standards of quality I demanded of my research publications. So, I focused on developing techniques that increased my speed and efficiency. After all, I had an enormous job and the faster I was the better I was.

Over time I developed so many techniques that I began to think that a computer/machine could perform many of my techniques automatically, which would increase my speed and efficiency. Turns out I was right. As long as my instructions were explicit enough, the machine could perform them. That is what New Constructs was originally created to do: develop the technology to scale my annual-report reading and modeling skills. See our Research Platform for more detail.

As stated above and in Economic Versus Accounting Earnings, the standard economic model is best because: though accounting rules may change from company to company or country to country, the basic economics of business are always the same. The basic economics of a business are: (1) how much real cash flow does the business generate relative to (2) how much capital has gone into the business over its life.

The challenge is that the economic model works only if it incorporates all available and relevant financial information. Moreover, the economic model is infinitely more useful to investors when it is available for all companies, not just a precious few.

Our patented system and proprietary technology enabled us to build a Research Platform that, for the first time, allows investors to rely on a comprehensive economic model when making investment decisions. No longer must investors rely on the accounting data that Corporate America and Wall Street publish. Now, investors have, via New Constructs, an alternative source of unbiased, complete information on the economic profitability and valuation of companies.

We have developed unparalleled expertise in interpreting accounting data and applying that to understanding the economics of businesses. We have unrivaled experience interpreting accounting data as we have parsed over 50,000  filings into New Constructs’ database over the past 7 years. Click here for more information on our Research Platform, which shows how we manifest the patent into a system that enables us to analyze the Notes for 3000+ companies.

NOTE that this patent is assigned to New Constructs. I am the inventor, and I assigned ownership of the patent to New Constructs in August of 2003. See assignation letter here.

Click here for a copy of the Official Patent.

To learn more about how well our system works for investors, see our Stock-Picking Accolades.

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3 Comments

  1. varadha says:

    Terrific, yet simple analysis. I’ve always been a fan of ROIC as a measure of capital efficiency and believe that no size/growth outperformance can replace the quest for efficiency.

    Sort of like a big gas guzzling v8 that needs ever increasing gallons of fuel to keep its engine running

  2. David says:

    But Angie’s $90 per user acquisition cost is going to go away. That’s what their approach probably is. How would their outlook be if that $90 cost dropped down to a total cost of $3 per user?

  3. David:

    That would be great, but cost per user acquisition is not something that’s very easy for a company to fix. ANGI can slash their marketing budget to the bone, but then they would stop acquiring new members. They would probably lose members in fact, as their membership renewal rate is at ~75% and declining. If they cut marketing expense by ~95% as you seem to be suggesting, ANGI might be able to eke out 1 year of slight profits, but they would start shedding members and losing money very quickly. ANGI’s only hope is to keep its marketing budget high and hope it can reach the scale and brand awareness to be able to sustain its business while scaling back marketing costs enough to turn a profit. The fact that ANGI’s revenue growth is slowing down even as its marketing costs keep increasing makes it very unlikely it will achieve that goal.

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