Newsletter October 13, 2003



In September I received official word that I had been awarded the Chartered Financial Analyst designation. Other details of my qualifications are available by clicking the “About” button above. This was a major achievement for me. However, I must remind readers that no one can be expected to “know” where the stock market is going. I do my best to apply fundamental finance and accounting knowledge and common sense. I hope to beat the TSX index on average, although studies have shown that beating the index is difficult to do on a sustained basis. And for any given stock, surprises can happen and I can in no way guarantee that I will get it right. However, I can continue to explain fundamental finance and accounting concepts and how they can be used to improve your odds in investing.

This newsletter has recently been sent out about every 3 to 4 weeks. The content and length vary. That will continue. The frequency of issuing this newsletter will depend on what I have to say. Much of my work is available in the Articles section and is well worth reviewing.

Understanding Stock Price Changes:

Click to access my article that explains how the reasons for stock price increases can be divided into just two distinct categories.

Identifying Suspect Accounting:

I notice that Biovail is in the news. The stock price has recently plummeted from over $40 to about $28 amid comments that the accounting is aggressive. In addition Biovail has commented that an analyst’s comments were “irresponsible and outrageous.”

I looked at Biovail about 18 months ago, March 19, 2002. At that time I called it a “Weak Sell” at $52.41.

Regarding Accounting concerns I said at that time:

ACCOUNTING AND DISCLOSURE ISSUES: I have major concerns regarding disclosure. Income under Canadian GAAP is vastly lower than under U.S. GAAP and I am at a loss to understand which is more realistic. In 2001 the accounting was complicated by changes in accounting principals affecting revenue recognition. There is a debt conversion premium that is difficult to understand. In my opinion management has not done a particularly good job of explaining these issues in clear terms. In addition the company loses money on third party contract R&D, and the reasons for this were not addressed to my knowledge.

Regarding executive compensation I said at that time:

EXECUTIVE COMPENSATION: The salaries are not excessive by today’s standards at $625,000 for the chairman and about $525,000 for the President. Unfortunately the stock options granted are obese and offensive in my opinion. The chairman received 900,000 options with a ten year life in 2000 alone. The company reports that these options had a value of $27 million. The chairman now has in-the-money options worth a staggering $170 million. And this does not count the “time value” remaining in his options.

In retrospect I was probably too kind. Maybe a company like Biovail could have and will do very well. But when I have concerns about accounting, even if it is my own inability to understand it, and when I see obscene executive compensation, I increasingly believe that I should run screaming in the other direction.

Sometimes accounting problems will not be detected, but I always look for accounting issues and when their is any doubt about the integrity of accounting, I believe it is best to invest elsewhere.

Exchange Traded Funds:

Exchange traded funds (ETFs) are somewhat like mutual funds. However stocks are selected by a computer program to match some index. These exchange traded funds do not pay managers to pick stocks. They also do not much, if anything, for advertising and sales costs to promote themselves. The result is that exchange traded funds have very low management expenses. Academic studies of the market often indicate that exchange traded funds area better choice than mutual funds. Canada was a pioneer in introducing exchange traded funds.

Visit the following site for details on 12 Canadian Exchange Traded Funds.

These funds can be purchased just like buying a stock. ETFs offer an excellent way to quickly move into and quickly out of segments including the market as a whole, or to bonds or the energy, gold, information technology or financial sector. You can also purchase exposure to the S&P 500 or to International Equity in RSP eligible funds.


Shawn Allen, P.Eng., MBA,CMA,CFA

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