Over the past week, one story has gripped the European financial world more than any other: the ongoing implosion of payments giant Wirecard AG (XTER:WDI), which was once one of the continent's top tech businesses.
As it turns out, Wirecard's numbers were wrong. The company has lost 2 billion Euros ($2.25 billion) of cash, and it's now trying to negotiate its survival with lenders.
The company's decline wouldn''t have come as a surprise to readers of the Financial Times. Over the past 18 months, the newspaper has been running an in-depth investigation into the company following speculation that some of Wirecard's business was misreported.
As the Financial Times proceeded to investigate Wirecard, European research analysts continued to tout the stock. The numbers looked great, they said, and the company was meeting all of its growth targets.
The company's subsequent revelations are a reminder of why it's so important to do your research when investigating a company. It's not enough to rely on the numbers. Those can be manipulated and adjusted to show the most favorable outcome. Instead, investors should approach companies like journalists chasing a story and pulling threads to find the answers they need.
This scenario reminded me of some advice Warren Buffett (Trades, Portfolio) once gave when he was describing how he'd come to invest in The Washington Post. Specifically, he made the following statement in 1991 as part of a series of lectures to students of Notre Dame:
"Bob Woodward one time said to me "tell me how to make some money" back in the '70s...I said "Assign yourself a story. The story is: what is the Washington Post Company worth? If Bradley gave you that story to go out and report on, you'd go out and come back in two weeks, and you'd write a story that would make perfectly good sense. You'd find out what a television station sells for, you'd find out what a newspaper sells for, you'd evaluate temperament.".... "Now, if you come back, and the value you assign the company is $400 million, and the company is selling for $400 million in the market, you still have a story but it doesn't do you any good financially. But if you come back and say it's $400 million and it's selling for $80 million, that screams at you. Either you are saying that the people that are running it are so incompetent that they're going to blow the $400 million, or you're saying that they're crooked and that they're operating Bob Vesco style. Or, you've got a screaming buy when you can buy dollar bills for 20 cents. And, of course, that $400 million, within eight or 10 years, with essentially the same assets, [is now worth] $3 or $4 billion."
This approach isn't straightforward or time-consuming. It might even be impossible if you don't have any experience or contacts in a particular sector. But that's all part of the research process.
If you can't figure out how much something is worth, or you don't have the experience, then the business does not fall into your circle of competence. If you can't figure out how the company is making money, it's probably best to avoid it. These are all parts of the research process, and the more research you do, the less risk there is of making a big mistake.
Unfortunately, there's no short-cut to this process. Some investors try to take a short-cut by relying on analysts. Many analysts do excellent work, but it is no substitute for your own research, and they tend to have a bullish bias.
Disclosure: The author owns no share mentioned.
Read more here:
- 4 Deep Value Stocks for the Current Market
- Young Warren Buffett on Conservative Investing
- Learning From Buffett's Early Experience With Berkshire Hathaway
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