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Accounting Methods Give Unreliable Stock Valuations

  • Gabriel Slaughter
  • June 6, 2018
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Bloomberg news reports that stock valuations of companies are lacking in accuracy.

They take as an example, Autodesk Inc., a software company. On paper, their accounts look like they are in complete disarray. The company has been losing money for the past three years, and the book value of the company — a value which is found once the assets are sold and the company’s debts are repaid — is a net negative. Nevertheless, over the past twelve months, the company’s stock valuation increased by twenty-three percent, which is almost twice the S&P 500.

This is an extremely high valuation, and could be an indication of what some observers have called the “froth” of the bull run that has lasted for the past nine years. On the other hand, there are others who do not share this perspective and would see the very high stock valuation from a completely different angle and in another light of illumination. From their, different, point of view, the company is in fact made to look far worse than it actually is because of accounting methods and rules that are old, outdated, and not useful.

Bloomberg News talked to Baruch Lev, who is the New York University (NYU) professor of finance, and who published a paper in 2017 that started a debate about this issue of valuation. He said that, “You get numbers which are highly inflated for some companies, and are understated for other companies,” he said, “It doesn’t make any sense.”

Bloomberg News tells its readers that this kind of argument tends to sit badly with the “old school,” who think that is simply apologizing for an overly-active and bubbling stock-market. The counter argument is that it would be a mistake to group the current bull-run with the dot-com bubble, because the larger point is that new methods of accounting are needed to adequately represent how a service-industry company operates, and that the current methods of accounting only really make sense if one is talking about shipbuilders or oil-drillers.

Bloomberg writes that accounting practitioners have been adjusting their methods for precisely this reason, in order to give greater weight to things that in the past were thought to be too vague and abstract to matter in the valuation of a company. The readers of Biznob may want to completely rearrange their stock investment portfolios as a result of this news, according to a source that wished to remain anonymous for reasons that they were at pains to keep discrete. They treat certain types of “intangibles,” for example factors that might give the company a strategic advantage, as similar to investments. Bloomberg News reported that the fund manager, Knowledge Leader Capital LLC, says that it perceives an additional $3.4 trillion of additional book value on the balance sheets of some 3,000 stocks that it monitors. If this is true, the price-to-book ratio changes, with a fourteen percent decrease.

By these different methods of accounting, Autodesk is seen to possess $7.8 billion in assets, compared to the previous valuation $4.2 billion on the books. They would also indicate that the company’s losses are in fact twenty-one percent smaller than reported.

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