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I recently spent a morning in a radio studio overlooking Times Square, connected by satellite with a series of radio stations around the country.
One by one I spoke with morning show hosts in every part of the United States, talking about the nearly incredible news from Wall Street over the previous few weeks. That morning WorldCom had just filed a new report with the Securities and Exchange Commission suggesting it may have overstated profits in even more years than originally believed. SEC chairman Harvey Pitt scorned the report as insufficient. WorldCom stock had finally reopened for trading and had fallen to six cents a share. The Nasdaq had just fallen to a five-year low. Vivendi had fired its CEO. Martha Stewart appeared to be in more trouble.
The questions on the broadcasters' minds were remarkably similar. Here are the big ones, plus what I said in reply:
How can investors know which companies they can trust?
The answer to this one is a little depressing. The truth is that most investors simply cannot verify the financial results of a publicly-traded company. How could we? A major corporation might pay one of the big accounting firms $10 million to conduct the annual audit, yet even these auditors don't look at every transaction; they examine only a sample. In addition, they've apparently been hoodwinked by some of the companies they were auditing.
How could that happen? Maybe through incompetence, maybe through laziness, maybe through duplicity or even criminality on the part of the auditors or the executives who hire them. But consider what a chief financial officer told me recently: He believes that accounting has become so complicated that no one outside a large, publicly-traded company can fully understand what's behind the company's financial statements. Bottom line -- individual investors simply can't conduct their own check on a company's veracity.
So what should ordinary investors do?
Forgive me for falling back on some old advice, but it's still the best: Diversify. Your best protection against accounting fraud is owning a wide range of companies.
Will there be more scandals?
This one's easy: Yes. Not that I know of specific companies that are about to announce some book cooking, but we can be certain that most corporate boards or CEOs are ordering deep investigations of their own companies' accounting, and we know that regulators have become highly interested in the same topic. We can be confident that this enormously increased scrutiny will turn up some of what it's looking for.
Have stocks hit bottom?
I wish I could say yes, but I don't see how I can - at least with regard to stocks overall. The market's P/E multiple is still high, and it's hard to see interest rates going much lower -- one of the most important factors in boosting stock prices.
But a couple of things must also be said. One, prices can in effect "go lower" without actually declining, if they hold steady while corporate earnings increase. Two, prices have declined sufficiently that there are now plenty of individual companies being offered at reasonable prices - at long last.
What the heck was Martha thinking?
A great mystery. Let's be clear that Martha Stewart has not been found guilty of anything, and she vigorously asserts that she did nothing wrong. But if she did what some investigators think she might have done - sold stock on inside information and then attempted to conceal evidence of it - she would be in big trouble. And for what? For $240,000 maximum, which is a lot to most of us but not much to someone worth hundreds of millions of dollars.
As you can see, we had plenty to talk about.
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