We’re Accountable for Investing Responsibly

Our definition of “contrarian investing” is to purchase stocks that are temporarily out of favour.

The reasons for any stock’s unpopularity can vary from a disappointing quarter, an operational misstep, or a poor allocation of capital.

However, investing in companies facing an accounting impropriety is a fine line we won’t cross. We view any kind of reporting fraud as being a red flag that suggests something is seriously wrong with the corporate governance of the company (and its people) behind it.

Often, these stocks fall straight to zero.

Late last month, Ernst & Young resigned as Super Micro’s auditor. Its statement speaks for itself:

We are resigning due to information that has recently come to our attention which has led us to no longer be able to rely on management’s and the Audit Committee’s representations and to be unwilling to be associated with the financial statements prepared by management, and after concluding we can no longer provide the Audit Services in accordance with applicable law or professional obligations.

Since this release, Super Micro’s stock has lost well over half its value.

Other notable examples of companies involved in accounting scandals are Enron and WorldCom. In both cases, these stocks became worthless within a few years.

Enron fraudulently reported revenue that didn’t exist. It also hid large debts off its balance sheet. Eventually, Enron’s CEO Jeff Skilling went to jail. Its auditor, Arthur Andersen, was also shut down. Shareholders saw their stock price fall from grace. It became nearly worthless in 2002 after hovering around $80 in 2000.

WorldCom fraudulently recorded their expenses as asset purchases. This inflated their assets by almost $11 billion. After touching just about $62 a share in 1999, the stock price plunged to mere pennies by 2002.

In recent years, many aspects of finance have become decentralized. Cryptocurrencies, for example, have removed many of the gatekeepers that exist to protect us.

Investors place significant reliance on these gatekeepers to prevent financial fraud from occurring. Auditors, regulators, and the company officers that personally certify their financial statements all play a role in making sure that financial statements provide an accurate representation of a business.

While we look for bargains as contrarian investors, accounting malfeasance is a line we won’t cross.

-written by Jeff Pollock