Answering Two Questions at the Heart of Uniform Accounting

Joel Litman

We recently received two great questions from reader Phil…

They get at the foundation of why we do the things we do when making our Uniform Accounting adjustments and “why it actually matters.”

Other readers have likely wondered the same things as Phil, so let’s take today’s Daily Authority issue to address these questions. We’ll start with his first one…

1. If most of today’s investors are only looking at non-Uniform Accounting data and only invest or trade based on this misinformed noise, does Uniform Accounting really matter? Stock price changes are mostly a function of supply and demand, and if demand is driven from non-Uniform Accounting data, does it become irrelevant?

First, it isn’t that most of today’s investors only look at non-Uniform data…

Here at Altimetry, we often talk about how Wall Street is totally missing the picture with the research it produces. When we say this, we’re referring to what’s called the “sell side.” Those are the research analysts from Goldman Sachs (GS), Morgan Stanley (MS), JPMorgan Chase (JPM), or Deutsche Bank (DB) that you see publishing research reports on companies and talking about them on CNBC.

Many individual investors get their insights from these folks. And the issue is these analysts don’t use cleaned-up accounting… They use GAAP accounting with a few minor changes, mostly to appease the companies they write about.

Wall Street sell-side shops produce this research to help convince companies to use their investment banking research. Their focus is on making the companies happy, not informing investors on which stocks to really buy and sell.

If you look at what “buy side” shops – the funds that actually manage your money – pay them for, they don’t pay them to pick stocks. Rather, they pay them for deep industry research and basically ignore the financial analysis and buy/sell recommendations sell-side shops give.

The buy-side firms – real investors – know that they can’t trust as-reported accounting.

In fact, nine of the top 10 and 200 of the top 300 investment firms by assets under management (“AUM”), read our Uniform Accounting research. Additionally, big firms like BlackRock (BLK) also hire waves of accounting professors because they understand the issues with as-reported accounting.

When you look at most companies on a Uniform Accounting basis in terms of what’s “embedded” in the stock price,” stock moves make more sense based on the Uniform numbers. This is far less frequently the case when you look at them using distorted, as-reported metrics.

If you’re using Uniform Accounting, then you’re looking at data behind all the big investment shops’ investment decisions… since they’re cleaning up the numbers. If you aren’t, then you’re missing critical information.

And that leads to Phil’s second question…

2. If Uniform Accounting becomes widely accepted and used by most investors someday, would using it for investing become less effective since everyone is using the same data?

Again, it makes sense that most times, when you evaluate a company using Uniform Accounting, the market looks like it’s “right” in what it’s pricing the company to do.

For the most part, the market is efficient.

But there will always be pockets where the market gets things wrong (because of emotionality, lack of consensus on a stock, or just missing the big picture).

Unless you’re using the right, Uniform data to vet a stock, you won’t know for sure if you’ve really found one of those mispricings.

Any good investment process shouldn’t find that 30% or 40% of the names in the market are mispriced… because if it does, it means that a lot of smart people are consistently getting things wrong.

From the investable universe of companies we could recommend in our paid products, we’re only finding 50 to 70 at any given time we think are compelling enough for a deeper dive. Uniform Accounting helps us spend less time “chasing ghosts” of names that look mispriced but aren’t, when you see the real numbers.

This is why we spend so much time focusing on the issue of ‘orange versus blue bars’ here at Altimetry

By breaking down in chart form how the GAAP numbers are different from the Uniform ones, we consistently show readers why you just can’t trust as-reported metrics. The savvy institutional investors certainly don’t trust them, either.

Leveraging the power of Uniform Accounting is how our Microcap Confidential service – devoted to the world of tiny-cap stocks – was able to outperform the Russell Microcap Index in its first nine months, since we launched it in July. Microcap Confidential’s overall return came at 129% versus 75% for the Russell Microcap Index.

And out of the 67 stocks we’ve recommended across Altimetry’s High Alpha and Altimetry’s Hidden Alpha, 39 have beaten the market, 25 of them are up more than 50%, and we’ve partially closed nine of the positions when they’ve more than doubled.

In fact, in Hidden Alpha, my team and I have applied our Uniform Accounting analysis to find stocks we believe are poised to benefit from society’s changing habits in the wake of the coronavirus pandemic. To learn more about Hidden Alpha – and gain instant access to the full portfolio of recommendations – click here.

Regards,

Joel Litman
June 1, 2021

P.S. If you have other questions about Uniform Accounting and our investing process, send an e-mail at [email protected], and we might devote a future Daily Authority to answering your question.