Use Your “Common Sense Filter” on Every Story for Better Results

by March 1, 2018

It’s been said many times before but continues to be great advice for journalists, especially young reporters covering business: Use common sense. (Image via Pixabay.com)

There’s a bewildering amount of data you face in reporting on business. But even that is dwarfed by the mountains of claims and hyperbole you hear from companies and their representatives.

It can be difficult to know whether the presentations are true and reasonable or an attempt to turn you into a promotional vehicle. There may be financial data, insights from independent experts, or other information that can help you make the call.

You can also use a tool frequently overlooked by business journalists: common sense. Basic logic and experience can’t explain everything, but they often put things into context or raise an alert that you should question something more closely.

No one gives a straight answer

The Enron accounting scandals and fraud took long to uncover because too many in the media allowed themselves to be dazzled and didn’t wonder why they couldn’t get straight answers. Bethany McLean, who was at Fortune, knew something was wrong in 2001. The company didn’t want to address questions and not even analysts knew how the company worked.:

But for all the attention that’s lavished on Enron, the company remains largely impenetrable to outsiders, as even some of its admirers are quick to admit. Start with a pretty straightforward question: How exactly does Enron make its money? Details are hard to come by because Enron keeps many of the specifics confidential for what it terms “competitive reasons.” And the numbers that Enron does present are often extremely complicated. Even quantitatively minded Wall Streeters who scrutinize the company for a living think so. “If you figure it out, let me know,” laughs credit analyst Todd Shipman at S&P. “Do you have a year?” asks Ralph Pellecchia, Fitch’s credit analyst, in response to the same question.

If you can’t get an understandable answer to basic questions even from industry experts outside the company, something fundamental could be off.

A company keeps losing money

Before Groupon went public, it regularly claimed how well it was doing. But even before an S-1 filing coughed up the levels of losses the company had faced, there was evidence of a growing bubble among the deal site sector. One of the big predictors was the realities of these promotions for the companies the deal sites counted as clients.

Advertisers must make money in the long run from the promotions for them to continue funding additional marketing that helped keep the deal company in business. Even if a company takes a loss today, it expects to more than make it up over time. However, deals sites took as much as half of the money consumers paid. The actual company providing the service being sold was now at a 50 percent discount and, unless it had unusually high gross margins, was losing significant money on every sale.

Additionally, the customers attracted from the promotions were driven by price, which reduces the chance that they’d become regulars once the costs were normal. The lack of repetition undercut the strategy of building greater lifetime value of customers once they began to do business. So long as the advertisers lost money and saw that they never made it up, there was no way a company like Groupon, LivingSocial, or any of the other deal sites could survive as they started. These days, LivingSocial is part of Groupon, which has seen some challenging times and, from 2012 through 2016, lost $489 million in its consolidated net income. The company finally made $26.6 million in 2017 — the year’s financials suggest largely from cutting SG&A costs — but that is still a drop in the historical bucket of red ink.

Too much attention on pro forma financials

As I’ve mentioned before on this blog, pro forma financials can be a big problem. But any publicly-held company still produces GAAP financials that aren’t tailored to promote the corporation. As I wrote in a 2016 story at The Fiscal Times:

Valeant, for example, provided a pro forma view in its earnings reports that, among other things, stripped out the costs of acquiring other pharmaceutical firms for their drugs — a key part of the company’s business model. Under that constructed measure, the company looked to be doing far better than it actually was.

Pro forma results should help give an idea of how a company is doing by filtering out anomalous events and circumstances. I remember speaking with the CEO of a semiconductor company years ago. He kept pointing to pro forma results and I insisted on looking at GAAP, or the standard form of accounting used in the U.S. The CEO argued that I wasn’t being fair because the measures were commonly used in the industry. I said that if the company had to keep making the same excuses year in and out, then that was part of normal business and should be considered.

Bring common sense, and a healthy dose of skepticism, to everything you see, hear, and read about companies.