Alternative Insight
Stock Market or Shock Market?
How to Make Money for Others
NOTE: This article previously appeared in November, 2000. All references to prices, company activity and dates are for the year 2000.
The article reveals some of the illegal schemes that eventually precipitated the decline of several American companies and the fall of the U.S. stock market. The fact that the "revelations" were public knowledge and available to the investment community and the government years ago prompts several questions:
(1) Why did the financial community ignore the public information and continue to allow the intolerable machinations?
(2) Why did the investment community ignore the public information and present falsehoods to the American investors?
(3) Why did the government wait until the companies went bankrupt and the public lost trillions of dollars before taking action?The original article has been highlighted to show that the failures of the U.S. government and American institutions to halt the financial improprieties have been more than careless. The improprieties were known. Failure to act promptly on the available financial information has caused economic havoc to many businesses and individuals.
The investment climate of the past decade convinced people that the stock market only exists for investors to buy stock in companies and make the investors rich. Reality has emerged from recent stock market activity-- the stock market primarily exists for companies and investment bankers to become rich from the stock they sell to investors. Investors who pursue a careful and rational approach to investing can benefit from their diligent attitude. However, they are similar to a crowd at an antique auction-- buying high and hoping one day to sell higher. The subdued facts have become loudly revealed. Some investors made tremendous money in the stock market. Most investors made tremendous money for others.
Profits Drive the Market
Fidelity Investments and their spokesperson, Peter Lynch promote a simple investment guide: Profits drive the market. The problem-- Fidelity has not defined the words "profits" and "market" to the basic investor. What are the real profits from the following reports?
The revenue and earnings for the third quarter reflect the Company's decision to transition its OAO HealthCare Solutions business from a perpetual license sales model to an application service provider (ASP) or subscription sales model. Specifically, half of the healthcare software license sales closed during the third quarter were sold on an ASP or subscription basis versus the traditional perpetual license sales model. This resulted in the revenues and earnings associated with the ASP deals not being realized in the third quarter, as is the case for license sales, but instead recognizing these on a monthly basis over the life of each contract.
LOUISVILLE, Colo., Oct. 26 /PRNewswire/ -- StorageTek (Storage Technology Corp.) (NYSE: STK) today reported third quarter earnings of $8.4 million, or $0.08 per share, excluding restructuring charges. Pre-tax restructuring charges of $3.4 million reduced earnings by $0.02 per share for the third quarter of 2000, resulting in a reported profit of $6.3 million, or $0.06 per share. The company reported earnings of $4.7 million, excluding one-time charges, or $0.05 per share for the third quarter of 2000. Revenue for the third quarter of 2000 was $486.6 million, as compared to revenue for the third quarter of 1999 of $573.7 million.
Do profits drive the market or does the market drive the need to show profits? The focus on profits has motivated some companies to manipulate their earnings reports, (example, Microstrategy) in a manner that assists their stock prices. Unlike the market controllers; professional investors, investment bankers, investment advisors, and brokerages, the public doesn't have the inside knowledge and experience to interpret the confusing earning reports. The insiders are more able to decipher the earning statements and use them to benefit their own investment strategies. This is only one part of a process by which powerful market controllers regulate the price of investments to their advantage. By a series of transactions the market controllers continually increase their wealth in a growing stock market. The wealth increase starts with the investment bankers who nurture and develop companies as a parent preparing a child for a future career.
How Money is Made in the Stock Market
It starts with the Initial Public Offering (IPO)
The IPO is a traditional method for making money in the stock market. In the last decade it has been the primary method. Although a part of the investing public has shared in gains from the IPO sales, the IPO is not constituted to buy stocks-- it is constituted to sell stocks and reward the venture capitalists, companies and investment bankers who prepare the sales. In the last years even the offering risk has been removed. IPO's issued by major investment houses have proceeded to market at inflated prices and then multiplied to prices that insured the IPO issuers would make substantial profits. Considering that many companies had little, or in some cases, no revenues, had their stocks escalate to high prices and then drop to almost nothing, the dotcom fever was more likely supported by inadequate advice than public exhuberance. Corvis, a fibre optics company, set a record as the most successful IPO for a company that had no revenues when it went public. Since that date, it has sold only $23 million of hardware to customers and lost $194 million. The stock hit a highof 110. It is now about 60. Corvis still has its proponents, unlike PSINet ($60 to almost $2), E.Spire ($16 to $2) and Global Telesystems ($35 to $2). Investors suffered greatly from these man made debacles.
Following the IPO are the mergers. After the chosen few of new industry leaders gain market acceptance, their stocks are promoted to high prices so they can either merge or purchase other profitable companies. Professional investors and bankers reap huge profits in this stage. The bankers arrange the mergers of new and older companies for fees. Professional investors use the knowledge of who will be favored and how their stock prices will increase and add the most favored stocks to their portfolios. In order to remain one of the "darlings of Wall Street", a company must consistently demonstrate fast growth. The mergers and acquisitions provide convenient paths to increased growth. The public only becomes aware of the risky and contrived techniques to achieve growth after the techniques finally fail and the stock drifts down to its true worth--failure.
Aether Systems Inc., a provider of wireless data software which had 3/4 quarter revenue of only $16.2 million, has taken stakes in modem manufacturer Novatel Wireless, e-commerce firm EPhones, biometric verification company Veristar and has bought the transportation unit of Motient Corp. Aether has exhibited characteristics of a bank rather than an electronics company. It has grown mainly from its investments and still has $1 billion in cash to spend from its March $1.4 billion secondary offering. Its sales in the March quarter were only $5.4 million.
By placing high valuations on selected companies, Wall Street has enabled those companies to acquire other companies at favorable prices. Cisco Systems, the highest capitalized company in the world, has grown from $69 million in revenue in 1990 to a $12 billion company today. Although Cisco has developed and marketed its own significant products, the revenue growth has been greatly external. In 1990, the two founders of the original Cisco were bought, noisily shoved out and then replaced by a high powered executive staff that capitalized on Cisco's earlier developments. Cisco's management continually used Cisco's elevated stock price to buy networking competitors and other valued companies. Over the decade, as Cisco's revenues increased 200 fold, its price-to-earnings ratio (P/E) increased 6 fold, from about 20 to a stratospheric120. The high P/E ratio afforded Cisco stock allowed the company to acquire lower valued companies.
The financing of start-ups who purchase equipments from the financing agent-- lending money to finance revenue--has been one technique to increase revenue. Several blue chip telecommunications companies increased revenue by that route. Lucent and Cisco contributed to the financing of ICG, a telecommunications start-up that no longer has sufficient funds to purchase equipments, cannot amortize its debts, and is seeking a buyer. Lucent increased reserve for bad loans by $170 million and its stock dropped 72%. WorldCom, whose stock has fallen 67 % in 11 months, reported a $405 million one time charge from nonpayment in its earnings statement. After leasing business software to its clients, USinternetworking reported a loss of $47 million on $28.3 million in revenue. Its stock hit a high of $66.67 in March. It is now at about $3/share.
Other contrived techniques for pursuing growth have been hidden from the public. Internet companies have traded advertising revenue and purchase of one anothers products. Many of the dotcoms advertised on each others sites. As one example, forty percent of Yahoo's ad revenues have come from other web sites. AOL financed hardware and software purchases from Sun Microsystems by having Sun agree to advertise on AOL sites. All of these manuevers add to revenue, but, with conventional accounting procedures, don't add to profit.
More hidden from a public that doesn't closely read and examine annual reports are that companies purchase equipment and advertising that boost revenue in other companies they partially own. AT&T purchases equipments primarily from Lucent, an AT&T spin-off. Softbank, a Japanese investor in several Internet companues purchases advertising space from Yahoo, a company they partially own.
More insidious are the auditing firms, that are responsible for certifying a company's books, and have displayed a symbiotic relationship with their clients. Pricewaterhouse Coopers, who signed MicroStrategy's erroneous financial statements for years, has sold licenses to MicroStrategy software and received consulting fees from the same firm.
Investors start selling if the retained earnings from years of losses become too negative and the road to profits seems out of reach. A trend of losses might mean eventual bankruptcy. Companies that have years of losses become forced to align their operations (and books) to declare profits, any profits by any means.
After a company starts declaring profits, investors demand continuous increasing profits. If profits slow or drop, the P/E will drop precipitously and the company's stock price will follow in unison. Companies, and the Wall Street forces that have popularized them, seek means to present a picture of intensive growth. Some means for portraying continuous growth are purely words. Companies use dramatic language to shift the focus to other portions of the annual report of a report that shows lower profits . If profits go down, a common strategy is to highlight that revenues have gone up or that cash flow is more important. Profits can be temporarily manipulated by adding unsold goods to inventories, adding to intangibles, etc. Many investors have not been aware that profits in many of the dotcoms came from interest on investments from the IPO sales. Major growth companies, such as Oracle, have displayed rapid profit growth from "one time" sale of investments. Oracle, whose stock price has dropped from 46 to 23, showed an income of $7.7 million for its quarter that ended on 5/31. Only $1.3 million came from operations; $6.6 million dollars came from "other income."
If rescue appears impossible then downgrade. Investment advisors bend with the winds and constantly upgrade and downgrade companies. Their advice often comes too late. Many investment advisors recommended Worldcom and Yahoo at their highs and didn't remove their recommendations until these stocks fell precipitously. Recently, Merril Lynch, A.G. Edwards, Bear Stearns and other brokerages downgraded electronics retailer Best Buy- after the stock fell from 52 to 32 in one day.
When stocks hit their growth peak, slow and non-publicized retreat from their high price occurs. Stocks mature and go through life cycles as if they were organisms. This cycle makes long-term investing an uncertainty. A great number of new companies, especially those in the internet sector, such as Dr. Koop.com, The Street.com, Value America, etc., which investors bought early for a long term, have collapsed in a short time. Venerable old-timers, who once seemed invulnerable, have suddenly been unable to combat competition and have had gnawing erosion in their profit margins and share prices. They have approached a preliminary stage to failure, the state of reduced credit rating. Xerox, the inventor of document copying, Kodak, synonymous with photography, and Polaroid, the genius of instant photo developing, are all in a fast decline. Wall Street has become pessimistic that these companies can reverse their declining process.
The surplus investment funds that served only to raise market prices are being offset by disinvestment. An impression has been made that the stock market would continually rise from an unlimited infusion of investment funds from 401k investment plans. This analysis did not consider that retirees would one day be withdrawing from their plans to support themselves with cash and more stable income producing mechanisms. This trade-ins will be accelerated after the "baby boomers" reach retirement age.The stress on money making money is giving way to a realization that hard earned money can also be easily lost, or more accurate, transferred to those who haven't worked for it at all.
alternativeinsight
november, 2000
slightly updated, july 2002HOME PAGE MAIN PAGE 
alternativeinsight@earthlink.net
