Check out my latest Danger Zone interview with Chuck Jaffe of MarketWatch.com.
Dean Foods (NYSE:DF) is in the DangerZone today.
When digging through the company's latest annual report, I found a surprisingly large amount of write-offs, including over $2 billion last year.
Write-offs are one of the clearest, yet most overlooked, signs of management failure.
- Given that managers are paid to create value, not destroy it, asset write-downs reflect management incompetence and failure to allocate capital effectively.
- Investors must beware companies that report artificially high profits due to the asset-write-down loophole.
More research on Hidden Management Failures: Asset-Write Downs.
Most investors are not aware of how many corporate managers destroy shareholder value because accounting rules allow them to erase their mistakes from financial statements. A little-known accounting trick called an "asset-write down" allows managers to simply remove assets and shareholders' equity from the balance sheet as if they never existed. It gets worse: this trick can be employed only when the current fair value of the asset falls below the book value of the asset. In other words, when managers have bought assets that are now worth less than their depreciated value, they can, with the stroke of a pen, remove those assets and the shareholders' equity that funded their purchase from the balance sheet. Effectively, this accounting loophole allows managers to hide their failures and makes it exceedingly difficult for investors to learn how much value they have destroyed. Write-downs also artificially inflate accounting profitability metrics and can make companies with lots of write-downs look more profitable than companies with no write-downs.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.