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In Scandal Aftermath, Help
For Investors Is on Its Way

By Art Berkowitz and Richard Rampell
November 6, 2002.

Many of our columns have focused on the difficulty investors (and analysts) have in getting an accurate picture of where a company stands. Some believe it is because of the flexibility in accounting rules. Others point to the complexity of today's regulatory requirements. Many blame the litigious nature of our society for the indecipherable legal language.

As in most things, there isn't one clear-cut answer. But often, it is when things seem the bleakest that opportunity arises. Many companies are now actively looking for alternatives to traditional financial disclosures, and perhaps even more importantly, being rewarded for their efforts.

Last month, Standard & Poor's completed its first Global Transparency & Disclosure survey, in which they ranked 1,500 companies, including the constituents of the S&P 500, on the transparency of their annual reports and regulatory filings. While the conclusions are based on just one year's data, the report states, "There is a growing body of evidence that supports the view that high standards of transparency and disclosure can have a material impact on the cost of capital."

What pleased us most was that companies are providing information beyond what is required by the SEC or other regulatory bodies. The additional information includes both financial and non-financial information -- the kinds of useful information that can help investors make key decisions when deciding whether or not to invest in a company. Three companies received an overall score of 9 out of a possible 10 on their financial information -- Baker Hughes Inc., Bausch & Lomb Inc., and Progress Energy Inc.

In addition, some companies have been providing additional information long before it became vogue. For example, Microsoft Corp. has been providing investors with the ability to manipulate the financial information on its Web site by providing historical data and detailed information in Excel spreadsheets. This allows users to drill down in the data and lets them project what earnings might look like based on different assumptions. They can also perform their own analytical review procedures, such as computing gross profit percentages or operating ratios, which typically aren't presented in the body of the financial statements.

Another positive idea has been the development of XBRL (Extensive Business Reporting Language). Originally developed by the American Institute of Certified Public Accountants to assist companies in the distribution of financial information, there is now a pilot project 1 to help investors more easily compare financials within an industry.

While all of the ratings and additional information are nice, what we really want to know is whether there is specific information that sophisticated investors use to make their decisions, and if there is a chance that this information may become standard in financial statements. The answer to both questions is yes.

We listened to suggestions from various sources regarding what information they would like to see. Surprisingly, one idea came up repeatedly. Lynn Turner, former chief accountant of the Securities and Exchange Commission, called it Key Performance Indicators. Murray Rudin, general partner of the private equity firm of Riordan, Lewis and Haden, called it metrics. But, regardless of its label, its effect is the same: Valuable information that allows the investor to make judgements about the future profitability of a company.

Every industry and perhaps every company within an industry has a set of data that is used to analyze the trends and profitability of the company. Mr. Rudin shared with us some of the ones his firm uses:

 Revenue per employee
 Same-store sales growth
 Revenue and gross margin per product line
 Recurring revenue as a percentage of sales
 Labor, materials, and overhead as a percentage of sales

The specific indicator (or groups of indicators) depends on the industry. For instance, health-care facilities often adjust their financial information by "bed days." This information permits a company to get a much clearer picture of what is going on.

So we went back to the companies rated the highest by the S&P survey and asked whether key indicators were a part of their disclosures. Refreshingly, the answer was yes.

Baker Hughes provides information they call business drivers in their annual report and online. For the oil-service business, one of the most important indicators is rig count. In fact, experts inside and outside of the company believe they can accurately estimate the profitability of the company just by tracking the rig count. In reality, we recognize that it is a little more complicated than that. But it does mean that there are key performance indicators that are increasingly becoming accessible to the average investor that will assist them in making the same kinds of analyses that sophisticated investors use.

So does that mean that investors have to go on the company's Web site periodically to track the company's rig count? Actually, at Baker Hughes, investors can sign up for a notification service where they will be sent e-mail every time the company posts new rig-count information. As they say in the commercial, "How cool is that?"

The one other tool that can make a significant difference for investors is the availability of independent research. This may the most positive development after the corporate scandals. The former system, where the major investment-banking houses were a primary provider of company research, was so flawed that it prompted former SEC commissioner Laura Unger to quip in response to a question at an investor conference, "It is more likely that we will see one dollar-a-gallon gasoline than a sell recommendation from an analyst."

Thankfully, this is an area where things are changing and changing rapidly. It wasn't that long ago that companies like Value Line, Standard & Poor's, and Morningstar dominated the independent research area. Many smaller boutique companies provided independent research on individual industry analysis, but at a fairly hefty price. Over the past several years, companies who were providing underwriting and trading services, with their vast resources, have dominated the research marketplace.

Now it is clear that independent research is once again a desirable asset. The investor will soon have a much broader range of companies and products to choose from. Even the big investment-banking firms are considering spinning off their research arms.

While these changes won't eliminate unethical practices and deceptive or fraudulent reporting, they are welcome news for investors who have become despondent over the barrage of negative information that has dominated the media.



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