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The Danger Zone Pick: 12/03/12

Monday, December 3rd, 2012

Check out my latest Danger Zone interview with Chuck Jaffe of MarketWatch.com.

Dean Foods (DF) is in the DangerZone today.
When digging through the company’s latest annual report, I found a surprisingly large amount of write-offs, including over $2 billion last year.

Write-offs are one of the clearest, yet most overlooked, signs of management failure.

  • Given that managers are paid to create value, not destroy it, asset write-downs reflect management incompetence and failure to allocate capital effectively.
  • Investors must beware companies that report artificially high profits due to the asset-write-down loophole.

More research on Hidden Management Failures: Asset-Write Downs.

Most investors are not aware of how many corporate managers destroy shareholder value because accounting rules allow them to erase their mistakes from financial statements. A little-known accounting trick called an “asset-write down” allows managers to simply remove assets and shareholders’ equity from the balance sheet as if they never existed. It gets worse: this trick can be employed only when the current fair value of the asset falls below the book value of the asset. In other words, when managers have bought assets that are now worth less than their depreciated value, they can, with the stroke of a pen, remove those assets and the shareholders’ equity that funded their purchase from the balance sheet. Effectively, this accounting loophole allows managers to hide their failures and makes it exceedingly difficult for investors to learn how much value they have destroyed. Write-downs also artificially inflate accounting profitability metrics and can make companies with lots of write-downs look more profitable than companies with no write-downs.

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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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