If You Don't Speak the Language, You Must Read This

The most important advice I ever received... The biggest mass deception in financial history... If you don't speak the language, you must read this... The further I went in my career, the louder my mom's advice... Leveling the playing field... Please join me this Wednesday night...

Editor's note: Professor Joel Litman is hosting a big exposé this Wednesday night...

Beginning at 8 p.m. Eastern time, Joel will walk everyone – including Porter, who will take part in the event – through how to use his "Investment Truth Detector" system.

This remarkable system allows you to immediately see a company's true earnings number... and where it's likely going next. Best of all, you can try it out for free leading up to this online event. Reserve your seat – and find out how to test-drive Joel's system – right here.

In the meantime, we've asked Joel to pass along more of his insights to Digest readers...

On Friday, Joel shared a piece of valuable advice from his mother that led him down the "truth teller" path. In today's Digest, Joel will explain why his mother's advice seemed to grow louder as his career progressed – and what he's doing about it now...

On Friday, I (Joel Litman) mentioned that it was my mom who got me into the 'truth teller' business...

When I was looking into universities and careers, she advised me simply: "Become an accountant. Learn the language of business. Then no one can pull the wool over your eyes."

My mom is a CPA. She is also an immigrant to the United States from the Philippines.

At the remarkable age of just 19 years old, she somehow completed all the requirements for accounting coursework at the university, sat for the Certified Public Accounting ("CPA") exam, and passed it on her first attempt.

She used that CPA license to get a job for the international oil company Esso Oil in the Philippines. Then, she began looking into how to transfer to the U.S. As soon as she could, she traveled to New York City and landed a position at one of the premier investment banks in the world – Donaldson, Lufkin & Jenrette.

At the time, she had a chance to attend the prestigious Wharton business school in Pennsylvania, though she passed it up. When I ask her why she chose to work instead of obtaining a higher education degree, she simply replied, "I was tired of going to school."

Learning accounting sounded like a good base...

It wasn't as exciting as marketing or finance. It didn't have a natural leadership angle like a management degree.

But it did seem like a solid foundation for whatever else I wanted to go into down the road. I told myself that I didn't have to be an accountant... I just needed to study it and then go and do something else.

So I followed my mom's advice.

I graduated, sat for the CPA exam, and started working in public accounting. I told you a little about the places that I worked and the mentorship that I received in the field in my Digest on Friday.

'Learn the language of business' was the most important advice I ever received...

And the second part of my mom's advice leads me to revealing the illusion that 99% of the public seems to have no clue about.

It's the advice that I open with at virtually every CFA program, every MBA seminar, every business speech I give. It's advice I need to pass along to all of you.

When my mom said, "Then no one can pull the wool over your eyes," she had no idea the gravity of her statement.

Most investors accept accounting as if it's a language they understand...

You read a company's earnings in a press release. You hear about the price-to-earnings multiple on CNBC or Bloomberg television.

The as-reported earnings, assets, debts, and valuation measures are the key words in the accounting language. They are discussed in the financial press every day. They're reported in every public company's financial statements.

And if you're like most investors, you probably think that these numbers are "real."

They aren't.

It's the biggest mass deception in financial history...

This is no secret to the greatest investors in the world. And if you listen to their language, you hear them speak directly to the wool being pulled over everyone else's eyes. As Bryan Beach wrote in the Digest on Thursday...

Just last year, [Warren] Buffett told his shareholders that net income "is not representative of the business at all." Seth Klarman, an investing legend in his own right, called net income "an accounting fiction."

The great billionaire investors of the world do not rely on the language of accounting as it's reported. They translate that language into economic reality... And only then do they make any valuation decisions.

They don't pay attention to the earnings forecasts and earnings-per-share announcements as stated. They always translate. They always adjust.

In fact, if you're not adjusting those figures in your own investing... if you're simply accepting the language without translation... then you shouldn't be surprised when your investments can't possibly do as well as theirs. You haven't yet pulled the wool from over your eyes.

However, if you listen closely to what the great investors say about this language, you can profit the way they do.

Early in my career, I realized how right my mom's advice was...

Only a few years before I got my CPA, members of the Financial Accounting Standards Board ("FASB") realized financial statements were in crisis.

There was already widespread confusion about the elements of the balance sheet, the income statements, and how earnings were being calculated. With just a balance sheet and an income statement, there was no way that investors could easily measure financial health.

FASB became fixated on a repair for this problem. It wanted a new statement that told the public what they needed to know. Rather than looking at confusing statements about "operating profit" or "earnings before interest and tax," FASB wanted a statement that reported one thing... cash.

It came up with something called the "statement of cash flows." It's still in place today worldwide.

In theory, the cash flow statement makes sense...

It's intended to track all the cash going in and out of a business over a period of time and categorize those cash flows simply. There shouldn't be any guesswork. Cash should be cash.

But even when I was studying for the CPA exam years ago, I could already see its shortcomings. This is one of the secrets that I need to share with you...

The cash flow statement doesn't work now, and it didn't work when it was introduced in 1987. It isn't actually a statement of cash flows. The components of cash flow from operations, investing, or financing are not grouped as stated. They weren't then, and they're still not now.

The general investing public has put too much faith into FASB.

If you read the supporting literature for the cash flow statement, you can see that the seven FASB members seemed to be in a rush. And three members stated publicly that there were too many kinks that had not been properly worked out... They admitted it was "confusing," "internally inconsistent," "misleading," and "likely to be misunderstood" by most users of the financial statements.

And they were absolutely right...

Most investors think the income statement provides an accurate statement of profits for a firm. It doesn't.

Most investors think the balance sheet accurately provides the assets and liabilities of the firm. It doesn't.

And the statement of cash flows? It was nonsense right out of the gate in 1987, and it hasn't gotten any better.

My mom's advice seemed to grow louder the further I went in my career...

If you don't understand the language at this level of understanding, then you'll end up like most investors... with the wool pulled over your eyes.

In fact, there's a shocking parallel between my mom's advice and the words of Seth Klarman, who runs the Baupost Group in Boston. One of the most prolific modern investors, Klarman's returns speak for themselves. At Baupost, he has outperformed the S&P 1500 – a combination of the large-cap S&P 500, mid-cap S&P 400, and small-cap S&P 600 – by more than five times since 1999...

Part of Klarman's success is that he had the same wariness of truth-telling in accounting that my mom instilled in me.

For example, right now, one of Klarman's biggest holdings at Baupost is online auction site eBay (EBAY)...

But it probably isn't because of eBay's as-reported numbers, based on generally accepted accounting principles ("GAAP").

As our "Uniform Accounting" analysis shows, GAAP as-reported return on assets ("ROA") significantly understates eBay's real profitability. The Uniform Accounting numbers are more than four times higher...

If you only focus on the GAAP numbers for eBay, it will look like the company has been showing top-line growth... but hasn't been able to translate it into profit.

But once we make our more than 130 Uniform Accounting adjustments to the as-reported accounting statements, eBay's adjusted earnings have risen more than 30% from 2015 to 2018 – from $1.9 billion to $2.6 billion. And it's forecasted to rise to $2.7 billion this year.

This company doesn't have languishing profitability like as-reported metrics reflect. In fact, it has been growing rapidly... And it's only a matter of time before the market finds out.

Klarman knows that you can't just look at the as-reported numbers. In his book, Margin of Safety, Klarman states bluntly that as-reported company financial statements and reported results are not to be relied on.

Specifically, Klarman says that the "analysis of reported earnings can mislead investors as to the real profitability of a business."

Financial juggernauts have been using eerily similar language for decades...

Don't trust net earnings, don't trust the financials, don't trust the accounting. Buffett says it. Charlie Munger says it. Marty Whitman says it. I could go on and on.

None of these great investors let the wool get pulled over their eyes. They don't let misleading accounting statements fool them.

And you don't have to, either.

For the past 10 years, my team at Valens Research and I have been working to translate the language of accounting into something that you can use to make investment decisions – just like the great investors of the world.

We make all of our adjustments – more than 130, as I said earlier – to correct distortions and inconsistencies in the accounting of public companies. That's how many adjustments it takes to get from the bad, misleading numbers to good, clean, apples-to-apples financials.

With our work, you can see a company's performance and valuation for what it really is. You are no longer dependent on terribly misleading financials.

Our goal is to level the playing field and take the guesswork out of investing in more than 32,000 companies worldwide.

As I alluded to earlier with the eBay example, we call it 'Uniform Accounting'...

We aren't the first to do this. Since the turn of the 20th century, investors have created great wealth by adjusting misleading financial statements into economic reality.

Every great investor I've mentioned above makes some combination of these adjustments.

In fact, nine of the 10 largest and most successful investment firms on the planet read our research. So do more than 180 of the top 300 investors in the world.

Make no mistake – many of these firms are also making many of the same adjustments we are... But they keep it to themselves.

That's why I'm so excited for this Wednesday night...

On Wednesday, September 25, beginning at 8 p.m. Eastern time, we're hosting a special online event. During the event, we will share with the general investing public our process that lets us see through the accounting noise into economic reality.

We'll show you how you can adjust earnings and the key performance metrics of a business... explain how investors like Seth Klarman consistently beat the market by providing "alpha"... and detail how you can stop relying on the as-reported, flawed language of business.

I hope you'll join in and listen.

I'll also be providing a live demonstration of our "Investment Truth Detector" system... uncovering the reality about some of the best- and least-known stocks in America. Plus, just for joining the webinar, you'll gain access to our No. 1 stock recommendation. Click here to reserve your seat.

New 52-week highs (as of 9/20/19): Axis Capital (AXS), Celgene (CELG), Lundin Gold (TSX: LUG), Medtronic (MDT), and ProShares Ultra Utilities Fund (UPW).

A quiet weekend in the mailbag. Are you planning to tune in this Wednesday? As always, you can send your thoughts, comments, and observations to feedback@stansberryresearch.com.

Regards,

Joel Litman
Manila, Philippines
September 23, 2019