The Hindu Business Line : The weakness of numbers

WHEN companies report sales and profits every quarter, nothing is more important than EPS, the lodestar that investors use to judge the health of companies. And EPS is the number for which all other numbers are sacrificed, says the blurb of The Number, a book by Alex Berenson about how the drive for quarterly earnings corrupted Wall Street and corporate America. Read on:

Used properly, accrual accounting is about timing, not about creating profits where none exists. Over the long run, the profits that a company reports under accrual accounting should jibe with the cash it receives and spends. Over the long run, companies that make sales to customers who can't pay will have to admit that their clients are deadbeats.

Outperforming the market is hard, and the more one trades, the harder it is, because trading is expensive.

Analysts did not pull their estimates out of thin air; companies guided them. Companies controlled the `consensus'; they told analysts how fast they expected to grow. And Wall Street's obsession with `consensus estimates' was only part of the reason that accounting chicanery erupted in the 1990s.

Real short-sellers are very different. They have the souls of detectives, not investors. They spend their days poring over financial statements, looking for clues to fraud: numbers that don't add up, footnotes that don't make sense, mysterious changes in accounting principles. They research companies more thoroughly than most longs, since unlike longs they don't have the advantage of having their questions answered by management.

None of this means that investors shouldn't try to find good, fast-growing companies. They do exist, and they can be great investments. But no company is perfect, and management often has interests far different from shareholders. In any era, investors would be wise to remember that, and to know how to find the truth behind the numbers. A healthy scepticism is the best defence against fraud; only when investors demand honesty about good news and bad will companies respond with the truth.

Take numbers with a pinch of salt, especially when they come in bumper sizes.

Number fun

IF YOU relish a challenge and can add, subtract, multiply, divide and raise a number to a power, and you know what a square root is, then try In Code by Sarah Flannery. Times Educational Supplement wrote: "If you want to find out how to get from Euclid's theory of prime numbers via Eratosthenes' sieve, Mersenne's numbers, Fermet's little theorem and Euler's Phi function to modern number theory, you can. If you want an introduction to cryptography from the old Caesar's wheel to modern double key encryption... it is in here". A few excerpts:

The great thing about puzzle-solving is that it is not always the professional who first finds the solution to a puzzle. Solving a puzzle is undertaking a journey and reaching a destination. Lacking the `vertical' training of the academic, the amateur by necessity must be more creative and is often rewarded by finding the shortest and most beautiful route.

You might think that because a number is `big' it is bound to have lots of factors, but surprisingly this is not always true. The number 889363, which is not far off a million, has only its two trivial factors. It has no proper factors. A single row of 889363 soldiers could never be rearranged into ranks and files so that each file contains the same number of soldiers. The natural number 2 is the only even prime number and so is considered the oddest prime of all.

The number 10{+1}{+0}{+0} has one hundred and one digits, beginning with one and followed by a hundred 0s. It is known as a `googol', a name invented by a nine-year old American boy. Numbers of this magnitude are commonplace in cryptography. 10{+1}{+0}{+0} = 4 (mod 7). So if today is a Sunday, then in 10{+1}{+0}{+0} days' time it will be Thursday. You shouldn't go through life without knowing this!

One-way functions are used to protect passwords by encrypting them and storing only the enciphered version. This allows a password to be kept absolutely private so that not even the system administrator knows it. When a `word' is first submitted as a password, the system encrypts it with the one-way function, and places the resulting `string' of gobbledygook in a file which is called a password file. No record of the word submitted is kept.

Read it if you are among those who always liked maths though it was not in the syllabus.

Coffee corner

ON THE world's first commodities exchange, fortunes are won and lost in an instant. Miguel Lienzo has lost everything in a sudden shift in the sugar markets. Impoverished and humiliated, he lives on the charity of his younger brother. Now comes a seductive Dutchwoman who offers Miguel one last chance at success — a daring plot to corner the market of an astonishing new commodity called `coffee'. That is a teaser for the novel The Coffee Trader by David Liss. Read on:

Trading combinations manipulated the markets all the time, but this plan — buying on other exchanges, creating a market to tempt a buyer — was beyond anything Miguel had ever heard.

Based on rumours of an impending shortage, received from a very reliable source, he had bought the brandy futures at a 70 per cent margin, paying only 30 per cent of the value of the total quantity up front, and then either losing or gaining as though he had invested the entire sum. Come reckoning day, if brandy increased in value, he would profit as though he had gambled on a much larger amount, but if brandy lost value, as now appeared inevitable, he would owe far more than he had already invested.

Coffee is like wine, one imam declared, and is therefore forbidden. But wine makes a man sleepy, yet coffee makes him alert. Therefore coffee could not be like wine. Another shouted that coffee is black, and the beans, when roasted, are like dirt. The eating of dirt was forbidden. But another argued that since fire purifies, the process of roasting the berries makes them not unclean. In the end they could only say that coffee was neither forbidden nor permitted, but was mekrub, undesirable.

Relish the book over a coffee, or instead of one.

(Books courtesy: Landmark, Chennai. www. landmarkonthenet.com)

Tailpiece

"I have thought of an easy way to save on telephone bill."

"What's that?"

"To talk without dialling."

hindubusinessline@hotmail.com

D. Murali

Article E-Mail :: Comment :: Syndication

Stories in this Section
Balanced, wide and well-mixed

Moving writ `to have the body'

Family is on leave-travel leaving me out

Why reinvent? There's knowledge to share

The weakness of numbers