Paint by Numbers
Accounting does a lot of jobs. It loosely translates what a business does IRL into numbers. Mostly it does a good job, like Rembrandt brushing a portrait. Once in a while, it turns a bit weird — a bit more Dali. You say "wait a minute! I've seen an elephant. It doesn't have super tall spindly legs and extra sets of ankles."
There are a few reasons this happens. One of them is who uses accounting. Different groups need financial statements: execs use them to manage the business, tax collectors use them to figure out how much they're owed, employees and customers use them to check if a business can pay them, investors use them to figure out how much the business is worth.
Each of these might want different accounting treatments. These different groups pull accountants in different directions. Keeping one set of books is tricky enough. So, there are some generally accepted accounting principles used across companies and users of financial statements.
Sometimes that means accounting misses what's important for one group in favor of others. Sure, sometimes there's some fraud or deception, but mostly there are just weird cases where accounting misses the mark of what's going on. The picture painted by accounting veers from realism into something a little wierd.
For investors, this can drive a wedge between what investors actually expect of a business and what they should expect. This "accounting wedge" framework crops up in a few of Lamplighter's investments.
Sometimes accounting blends things together that are better evaluated with more contrast
IDT sells some old-timey telecom services and it sells some whizzy new services to a tight-knit customer group. The old timey things are going away slowly. The new services are thriving. The Company's financial statements paint a picture of a stodgy, old dinosaur. The old services are the bulk of the business. Investors have bought into this picture the past few years. But most of the value of the business today comes from its high-growth, high-margin efforts.
Sometimes accounting pulls expenses forward that match revenue far in the future
Planet sells pictures taken by its satellites and insights from those images. This is a newish business. It's been experimenting with different styles to best deliver value to customers. Some of its efforts clearly work. Others need some fine tuning. It spends most of its dollars on investments that'll pay off in the future. Since some of them won't work out though, accountants run them all through the P&L now. This makes the company look less profitable. Its unit economics are great — it doesn't take a lot of expense to run a satellite once it's up. It's the only company that can provide this stuff in many cases. Customers regularly find new uses for the product. Investors have struggled to process the mismatch between when Planet spends money and when it realizes value for those expenses and the choppiness that comes along with new businesses.
Sometimes accounting paints in broad strokes and fails to capture the balance of a business
Marex moves risk. Customers deposit cash with it to facilitate this. Marex earns interest on those funds. This makes it look a bit like a bank. Accounting says Marex's income and earnings are tied to interest rates. The business, though, earns income on the volume of customer transactions and the value it delivers to them. When rates are higher, like today, income shifts to the interest bucket. When rates are lower, income shifts back to customers. They foot more of the bill directly in fees and commissions. Under both conditions, though, Marex’s income depends on volume not on rates.
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Accounting is a compromise. Lots of different groups need to know about the performance of a company. On their own, they'd all come up with different ways to translate stuff a business does into numbers. Accounting tries to square this circle. It mostly does OK. But, when it doesn't — when it paints a picture of a company that’s different than one that best describes its value — investors can use that space to find appealing investments.
Disclaimer: None of this is investment advice. It's meant to illustrate ways LCM thinks about investing. Things that LCM decides are good investments for LCM and its clients are based on many criteria, not all of which are covered here. Some or all of LCM's ideas may not be suitable for other investors. LCM does not recommend investing either long or short any position mentioned. LCM may own positions in some of the companies mentioned. Some of its ideas will lose money — investing entails risk. See full disclaimer here.