FINANCIAL  STATEMENT  ANALYSIS 

           "When you go into the stock market you're competing with professionals.'" [1] "[T]he obfuscatory verbiage of people who speak Wall Street [] treat finance as a kind of secret, clubby code.... [They] deride dabbling investors." [2] In order to succeed, an investor needs to understand the language of business.

           "Accounting is said to be the language of business. Great investors are skilled at financial statement analysis. It allows them to look at the past and project the future. … Numbers tell a story. Financial statements are the report cards of the companies." [3] "Even after disclosure, the numbers that some companies report are based on accounting methodologies so complex, involving such a high degree of guesswork, that it can't easily be determined precisely how they were arrived at. Hard to understand doesn't necessarily mean inaccurate or illegal, of course. But, some companies take advantage of often-loose accounting rules to massage their numbers to make their results look better. … [T]he [] problem is for investors to figure out how accurately the numbers reflect a company's business. … Hence, companies have an incentive to use aggressive -- but, under the rules, acceptable -- accounting to boost their reported earnings and prop up their stock price. In the worst-case scenario, that means some companies put out misleading financial accounts." [4]

           "Experience is the best teacher, but the tuition is high." [5] Our Excel-based spreadsheet—Historical Analysis v2.3 (HAv2.3)—might be able to short cut the learning process for you and your wallet.  HAv2.3 provides you with an organized and credible means to work through the somewhat indecipherable information in financial statements.  

         Instead of depending on others to oversee your stock investments, it is essential to cultivate self-reliance for achieving success. Financial advisors often find it easier to persuade individuals that they possess knowledge, rather than actually having profound knowledge themselves. "Consultancies choose new employees in part based on their ability to project answers with confidence. … '[A]nswering a case perfectly but nervously will get you rejected.'" [6] "New research from Shanghai Advanced Institute of Finance similarly finds that comely managers of mutual funds lure more investments and enjoy more promotions than their homelier counterparts, even though their funds don't perform as well. The researchers suggest this performance gap may be because handsome managers approach risk with hubristic levels of confidence. … Basically, we tend to assume that good looks are a sign of intelligence, trustworthiness and good character…." [7]

          "Who should you trust for investment advice? ... Surely they'd be investing their own money in their ideas ... and ideally their wealth would derive more from their own personal investing returns [rather] than from selling their ideas to people like you." [8] "Most people on Wall Street don't make money by investing—they make money by helping others invest, charging a hefty fee for their service. Warren Buffett called these people the 'helpers,' and warned investors to avoid them at all costs. The reason: very few people have the skill to beat the market. …  The helpers, of course, are well aware of this. So, in order to try to be one of the chosen few who beat the market, they take more risk, swinging for more home runs instead of more reliable singles and doubles. That's what can lead to big losses…. The lesson: Stay away from money managers who charge hefty fees for complex strategies." [9] "[W]hile many people believe that the essential skill of being a hedge fund manager is picking good investments, in fact the essential skill is continuing to run a large hedge fund that pays them a lot of money. ... Building a robust institution with high fees, loyal investors and long lockups is a deeper and more fundamental skill than picking the right stocks." [10] "[A]s funds get bigger, their income from management fees, which is based on the amount of assets they have, grows. That gives managers fewer incentives to improve performance." [11] "Fund investors… [have a] chronic compulsion to chase hot performance and flee when it goes cold. Such buy-high-and-sell-low behavior tends to flood fund managers with cash at times when stocks have already risen in price—and to force the funds to sell stocks after a decline. The managers can perform only as well as their worst investors allow them to. … If fund managers could stick to only their best ideas, they might do better. But owning just a handful of stocks could create tax and regulatory headaches—and would expose the managers to massive withdrawals (and loss of fees) if returns faltered. So most portfolio managers own too many stocks to focus on their best ideas…. " [12]           

          Self-reliance may be the answer. "Amateur investors have always had advantages over professionals: They can't get fired for underperformance, don't have to incur commissions and other fees, and don't have clients who give them money (and take it away) at the worst time. They can invest for the long run and ignore the short term." [13]  "One advantage small investors have over professionals: They don't have to worry about reporting performance to clients. That helps some individuals feel comfortable riding out market downturns." [14]

       Our investment strategy is rooted in analyzing financial statements and has been thoroughly tested, backtested and validated. With HAv2.3, you have the ability to identify value stocks for investment and also prevent investing in companies that are facing financial difficulties. This allows you to make informed decisions before the stock market prices adjust to reflect the true state of these companies. Please review our Sample Analyses.  "By backtesting —applying hindsight to past data and pretending that a hypothetical portfolio had been run that way all along—financial marketers can make outperformance look ridiculously easy. … Of course, you can't completely ignore the past when you project the future. To protect yourself against backtests that foretell nothing, ask questions like these: If this idea is so great, why weren't these guys using it at the beginning of the period instead of only at the end? Why wasn't everybody using it? How long has the strategy actually been used, and with how much money? Has it been tracked over even longer periods than reported in the backtested data? How many other strategies were backtested but abandoned? Do the past numbers include trading costs? If the answers don't make sense, don't invest." (WSJ, 5/31/24, "When Past Performance Doesn’t Even Predict Past Performance")

        HAv2.3's quality of earnings analyses comprise several numerical formulations of the fundamental principle that "distorting one section of the financial statements throws the numbers out of whack in some other section." [15]

       On the investment side, it can be beneficial to consider slowly accumulating or purchasing stocks at lower market prices, as long as those stocks are still financially stable and not at risk of bankruptcy. However, it is crucial to have the necessary emotional resilience, patience, and financial resources to endure potential market fluctuations. "[S]uccessful investing depends, at most, 10% on knowing what to do and at least 90% on knowing what not to do." [16]  On the other hand.... "Here's the lesson... After a stock has fallen so hard, there's a tendency to think it has already been pummeled enough, so the worst must surely be over. … But if I have learned nothing else over the years, and should be exceedingly clear here: It's that just because a stock gets hammered doesn't mean it can't get hammered even more." [17] HAv2.3 analyses reveal the quality of stock-investment opportunities. 

        "The market wisdom that sounds the easiest can be the hardest to follow. Take 'buy low, sell high.' Buying low and selling high is logically sound but emotionally harrowing. That's because it requires buying something that feels risky because it just went down, while selling something that feels safer because it has just gone up. … Whenever markets move sharply up or down, it's human nature to want to take action. … Taking calm, contrarian action in a crazy world is a great way to restore balance not only to your portfolio but to your frame of mind." [18] HAv2.3 helps to recognize stock-investment entry points and exists. 

        If you have any inquiries, feedback, or suggestions, please feel free to reach out to us at: FSA@ConcernedShareholders.com.

INTRODUCTION - Financial Statement Analysis Applied to Stock-Market Investing

            The Investment Process

            Investor Psychological Traits

            The Market Cycle: Up

            The Market Cycle: Down

            The Opportunity

            Value Investing

I.        The need to "do" complex

II.       Financial Statement Analysis can "do" complex

            A.    Background

            B.    Historical Analysis v2.3

            C.    Projection v2.3

III.     Recommended Readings

IV.     Learn By Negative Examples

V.       An Approach to Stock Investing 

VI.      Financial Statements in the News

VII.    Sample Analyses

           Disclaimer

Financial Statement Analysis Applied to

Stock-Market Investing

        Successful stock market investing necessitates a strong foundation in financial knowledge, a comprehension of collective behavior, and a positive mindset. "[T]he penalties for financial ignorance have never been so stiff." [1] "If we truly ... can't make heads or tails of a complicated set of [financial] statements, we pass and move on." [2] "[I]f you invest blindly you stand an excellent chance of being blind-sided." [3]

        In order to achieve success in investing, it is crucial to possess a strong sense of mental discipline. "'Patience is one of the most important things in our business,' [CFA Howard] Marks said. 'And what I like to point out is that sometimes we have a sense for what's going to happen. We never know when. Most of the important things that happen in our business ... are primarily attributable to changes in psychology, not fundamentals.... And psychology cannot be predicted and certainly cannot be timed.'" [4]

        HAv2.3 helps achieve disciplined investing and financial success. 

        The Investment Process

        "In 1970, [Peter L. Bernstein] ... counseled investors to take big risks with small amounts of money rather than small risks with big amounts of money." [5]

       "Investing isn't about mastering the markets; it's about mastering yourself. … To be an intelligent investor doesn't require a stratospheric IQ. It does require discipline and the ability to think for yourself. …[I]ndividual investors are 'scarcely ever' forced to sell stocks or funds and—unlike professional portfolio managers who are continually measured against the market—are never compelled to care what other investors are doing. That independence is your single most valuable asset, a luxury most professional investors can only dream of possessing. … [I]t has never been harder to be a disciplined and independent investor. … After all, it often makes sense—and just feels right—to join the herd. … [B]ucking the consensus engages circuits in the brain that generate pain and disgust. Experiments have shown that when you find out your peers disagree with you, your choices become up to three times more likely to match theirs, although you have no conscious awareness of being influenced. … Instead of seeking to fulfill their own financial goals, they will strive to beat everybody else, becoming up to twice as likely to buy a risky stock. …  Because you may never realize how much a group is influencing your decisions, it's vital to protect yourself before you join the crowd. … Instead of investing based on the whims of the crowd, follow policies and procedures. …  Use a checklist to focus on the stability of the underlying business rather than share-price movements. Have I read the company's financial reports? Do its executives ... use conservative accounting ... ? … After thoroughly filtering companies, put your favorites on a watchlist. Set limit orders in your brokerage account to buy them automatically if they drop, say, 25% in price. That way, you lock yourself into doing the opposite of the crowd." (WSJ, 11/17/24, "You're Not Paranoid. The Market Is Out to Get You.") Now that you are in, what about getting out with a profit and a smile?

          "It all starts with a well-defined process that is executed with a high degree of discipline. ... There are a lot of smart people in the investment business, but not very many of them are consistently successful. ... We think the reason is that not many of them have a truly well-defined process and are truly disciplined in executing it." [6] "In this world, data can be used to make sense of mind-bogglingly complex situations. Data can help compensate for our overconfidence in our own intuitions and can help reduce the extent to which our desires distort our perceptions." [7] "[B]iases are hard-wired into our brains and personalities: Some of us are overconfident, taking excessive risks; others too meek, seeking to avoid losses at the first sign of trouble. … Some mistakes [] arise from the tendency to feel pain from a loss more acutely than pleasure from a gain. Investors sell too quickly when holdings take a few hits, and hesitate to build big positions in stocks they like. … It's one thing to be aware of behavioral biases; it's another to keep them in check." [8]

          "[R]esearch shows that ... focusing first on the positives of a purchase or decision makes it harder to come up with the negatives—and vice versa. ... When you're weighing an offer or decision, always start with your list of 'cons' before considering the 'pros.' It may save you a bundle." [9]

        "Companies, if granted the leeway, will surely present their financial results in the best possible light. And of course they will try to persuade investors that the calculations they prefer, in which certain costs are excluded, best represent the reality in their operations. …  But these are actual costs, notes Jack T. Ciesielski, publisher of The Analyst's Accounting Observer. 'Selectively ignoring facts can lead to investor carelessness in evaluating a company's performance and lead to sloppy investment decisions,' he wrote. … It puzzles some accounting experts that the Securities and Exchange Commission has not been more aggressive about reining in this practice. … The bottom line for investors, according to Mr. Ciesielski … is to ignore the allure of the make-believe. Real-world numbers may be less heartening, but they are also less likely to generate those ugly surprises that can come from accentuating the positive." [10]

        "Mr. [Howard M.] Schilit's firm, the Center for Financial Research and Analysis, scours corporations' books.... He says his sleuthing cannot pinpoint fraud. Rather, examining public documents often turns up gimmicks or aggressive accounting aimed at camouflaging problems. 'You never have a smoking gun,' he said. 'So you have to be careful about alleging wrongdoing. My job is to find an early sign of problems.'" [11]

        "[M]ost value investors are being put out of business….  [M]ost market participants these days are not trained or experienced in value investing…. Fewer players means there's no one to notice what’s happening to these companies and 'nobody knows what anything is worth,' [David] Einhorn said. 'So there's an enormous number of companies that are dramatically mis-valued in ways that we haven't seen before.'"[12] Mis-valued on the low side means buying opportunities for those who do financial statement analysis!

        Investor Psychological Traits

        "Happiness from wealth comes from gains of wealth more than it comes from levels of wealth. While gains of wealth brings happiness, losses of wealth brings misery." [13]

        "'What's the personality of the most successful investors?' asked William Bernstein, a neurologist.... 'They aren't affected by other people's feelings. In fact, the most empathetic people I know are the worst investors.'" [14] "As the late economist Charles Kindleberger put it: 'There is nothing as disturbing to one's well-being and judgment as to see a friend get rich. Unless it is to see a non-friend get rich.'" [15] "Just look at financial markets now. An activity that people have historically pursued in isolation—buying and selling stocks and other assets—has become the hottest way to socialize. … But what investors need most at a time like this isn't affirmation from hordes of strangers who think alike." [16]

         "When investors have different goals and time horizons—and they do in every asset class—prices that look ridiculous for one person make sense to another, because the factors worth paying attention to are totally different. … Bubbles form when the momentum of short-term returns attracts enough money that the makeup of investors shifts from mostly long term to mostly short term. … Bubbles aren't so much about people irrationally participating in long-term investing. They're about people somewhat rationally moving toward short-term trading to capture momentum that had been feeding on itself. What do you expect people to do when momentum creates a big short-term return potential? Sit and watch patiently? Never. … And the short-term traders that flood in operate in an area where the rules governing long-term investing—particularly around valuation—are ignored, because they're irrelevant to the game being played. … Few things matter more in investing than understanding your own time horizon and not being persuaded by the price actions caused by people with different time horizons." [17]

         "What will financial marketers sell….? The same thing they always sell: whatever did the best last year. … [Y]ou'll hear a lot about what was hot. … Those who were up the most always brag the loudest. … Extreme performance can last for a while, but it can't persist indefinitely. … It takes determination to resist the easy temptation of chasing whatever has been hot…. If you're tempted to play catch-up out of fear of missing out, at least limit the amount you put at risk. …  If you don't think you can stay that course, then … declar[e], up front, that you have no interest in chasing whatever has been hot. … That silences the hype. That opens your mind to the kinds of neglected opportunities that often do best when last year's market darlings fall from grace. And that keeps you from expecting the coming year to repeat the past year. They seldom do." [18]

        "People buy things that are going up, especially when they're feeling rich. It's called the 'momentum' strategy, and it generally works very well, until it doesn't." [24] "I once defined a bull market as 'a period of rising prices that leads many investors to believe that their IQ has risen at least as much as the market value of their portfolios. After the inevitable fall in prices, they will learn that both increases were temporary.' ... [S]tay humble!" [25] "Financial adviser and historian William Bernstein, in his new book The Delusions Of Crowds: Why People Go Mad in Groups, calls this 'vehemence, verging on raw anger, directed at doubters,' and says it is often the final phase of financial bubbles. … Perhaps anger tends to foreshadow the end of financial manias because it makes skepticism almost impossible." [26] "It's a bubble, according to a survey of retail stock investors. And they don't want to miss it. … Stocks have been on a tear for more than a year, and bubble warnings have rung out during most of that time." [27]

        "The businesses have little in common, but all rely for high valuations on buyers willing to bet on a story—and have benefited from the surge in individuals trading stocks. … [Those] assets [] look more like gambling tokens than ownership rights[.] … [S]peculative stocks and crypto depend for their value on stories, not on reported earnings." [28] "Cryptocurrency ... [is] backed by no government, is all but impossible to use and serves no legal need." [29] "The stocks of E.V. companies have already risen to shockingly high levels. And some have yet to make any cars, let alone profits. … [T]he mania also reflects the general bullishness that has swept up many assets, which can be hard to link to traditional financial fundamentals.  The run up in share prices illustrates investors' enthusiasm…. Take Lucid Motors, which started delivering sedans…. Lucid's shares, which have more than doubled in the past month, give the company a market value of nearly $90 billion, or $10 billion more than Ford, which sold nearly 4.2 million cars last year. Rivian, an electric pickup maker that has yet to start selling vehicles, went public last week and is now worth $127 billion, or more than G.M. And then there is Tesla, of course, worth over $1 trillion, or as much as nearly every major carmaker combined. … Aswath Damodaran, a New York University professor who is considered an authority on valuing companies, isn't so sure about all of this. 'Let's be quite honest,' Damodaran told DealBook. 'Wall Street analysts are not valuing Rivian or Lucid. They are chasing the price, and finding ways to rationalize it.'" [30]

        "[Y]ou got to know—When to hold 'em—Know when to fold 'em—Know when to walk away—Know when to run…." [31] "[T]he investor commandment [is] get out in time." [32] "[I]nstitutional investors … mostly pay attention to buying, not selling….  [T]hey just sell whatever has gone up a lot, or whatever has gone down a lot. … The basic folksy rule-of-thumb wisdom for buying is about fundamentals, but for selling it's usually about price action. Not always: One classic maxim is that you should dispassionately re-analyze each position each day, and if you wouldn'nt buy it now you should sell it. But just typing it like that makes me suspect that it is an ideal that no one really lives up to. It sounds like a lot of work!" [33] (Using HAv2.3 involves a lot of worth.) "They actually do OK figuring out what to buy. But they need to do a better job unloading stuff. … Purchase decisions are forward-looking, conducive to an analytical process that seem to be consistent and quantifiable. Selling stock in a portfolio is backward-looking; the retrospective nature seems to be susceptible to the kinds of behavioral biases and cognitive errors we typically think of as common among non-professional investors. … You might think that selling stock, so important to the total return of any portfolio, was a well-understood science. But you would be wrong. Instead, asset managers often lack any sound analytical framework for selling, using crude rules of thumb or gut instinct, neither of which has a good record for yielding positive results. Indeed, the most common reason to sell seems to be to buy the next great investment idea." [34] "'Ask yourself: Would I buy it now?' at the current price. 'If so, stay with it. If not, let it go,' Mr. [Marc] Gerstein [Director of Investment Research at Multex." Bernard Baruch noted, "I made my money by selling too soon." (See, An Approach to Stock Investing, below.)   

        "When looking at success, the first step is understanding why you succeeded. Was it luck? Hard work? Innate talent? ... When we only focus on outcomes, we miss important information about what went right (and wrong) and why. ... Analyzing successes ... should be mandatory. The military holds 'after-action reviews' ... irrespective of outcome. ... [D]iscuss four key questions: What did we set out to do? What actually happened? Why did it happen? What are we going to do next time?" [35] "We use outcomes as a simple indicator and then weave narratives around these views. We take a difficult problem, simplify it (are the results good or bad?) and then create a story to justify the outcome. ... There are no easy solutions here but being beholden to outcomes alone is by no means a panacea. ... [U]sing outcomes as a proxy for sound decision making in investment is anything but." [36]

       "[I]f we learned anything in this crisis, it is that most of the sophisticated financial professionals in the world were no better at predicting the market than some amateur investors. [37] "To become a market-destroying 'it' group on Wall Street, you need some arrogance, enough brains to justify making huge financial bets, utter cluelessness about lessons from finance's booms and busts, and a sincere belief that your unique contributions to Wall Street will mean, ahem, that this time it really is different, so old truths can be ignored. ... Everybody knows, though, that to really be part of Wall Street's elite, you've got to have contempt for the little people." [38]

         "'Investing is more than something utilitarian,' says Meir Statman, a finance professor at Santa Clara University and an expert in behavioral finance. 'People get pleasure from it. It's thrill-seeking behavior. It occupies time. People use investing the way other people go to concerts or go to parties.' … But these days, when indexers sin, often they sin by loading up on value stocks, those companies that are cheap compared with current earnings or corporate assets. Recent academic studies -- most notably a June 1992 Journal of Finance article by professors Eugene Fama and Kenneth French -- suggest that you can earn market-beating returns by buying value stocks. … But activity is so much more fun than inactivity, so we end up trading more than we should. … I would cap the 'fun money' portion of your portfolio at 5%." [39] "Technology can make investing easy and fun. It can also downplay risk in ways that may lead novices astray. … Robinhood has become so popular largely because it helps get new investors started by making the stock market feel fun and engaging. … [R]obinhood … makes me wonder whether it has created a game in which many of the most vulnerable players may end up being played." [40]

         "For some people, it seems, nothing has become too stupid to speculate on, as long as you can be reasonably confident that somebody even stupider will buy it from you at a higher price. … In that case, why not buy something that's a total joke? The answer, of course, is the same as it's always been: Sooner or later, after every marginal fool has piled in, you will end up looking to your right and looking to your left and then realizing, with a sudden chill running down your spine, that only one greater fool is left, and it's you." [41]

        "Behavioral mistakes are particularly rife in the small-cap stock pool, where investors make bigger errors because they tend to have less information and companies generally receive less scrutiny than your Alphabets and Apples…. If the company's fundamentals are sound and investors are fleeing while insiders are buying … the crowd is making an emotionally fueled mistake. … [T]he babies [are] being thrown out with the bath water." [42]

        "'Investors hate uncertainty.' Well, that's just tough. Uncertainty is all investors ever have gotten, or ever will get, from the moment barley and sesame first began trading in ancient Mesopotamia to the last trade that will ever take place on Planet Earth. ... The only true certainty is surprise." [43] "Part of what makes bear markets so unbearable is that nobody—and I mean nobody—knows when or how they will end. … Bear markets sometimes end in a selling frenzy, but they often end in an indifferent stupor." [44]

        "Knowing he owns good businesses, Mr. Buffett wants prices to go down, not up, so he can buy even more shares more cheaply before the bounce back. ... [A] bear market is a gift from the financial gods--and the longer it lasts, the better off you will be. Instead of running from the bear, you should embrace him. ... The real secret to being, or becoming, an intelligent investor is bolstering your self-control. ... [T]hose who can take the pain of a bear market ... will ultimately triumph, by patiently amassing greater and greater equity positions at better and better prices." [45] "[I]f you have plenty of cash and courage to withstand further declines, other people's fear could be your cue to act. … 'It is sometimes said that to be an intelligent investor, you must be unemotional. That isn't true; instead, you should be inversely emotional.' That means market declines don't have to be a cause of consternation. They can be an opportunity." [46] "The next time the stock market crashes, we all will step forward and buy stocks boldly--at least in our imaginations. But buying stocks when the market collapses is far harder to do than to imagine. … [F]ocus[] on a small number of stocks trading at low multiples of their value as businesses… [B]uy when blood was running in the streets…. [B]ear markets are so unpredictable that reliably sidestepping them is nearly impossible—and that the pain of losing money is nearly unbearable. … Since, over the long run, stocks tend to go up more than they go down, one of the greatest advantages an investor can have is the gumption to buy stocks aggressively in falling markets. That requires both cash and courage. … [S]teel your courage. Write a binding contract with yourself, witnessed by a friend or family member, committing you to buy more stocks when they fall 25%, 50% or more. Years from now, you will be glad you did." [47]

        Now, with all this positive feedback, one only needs to understand the methods for evaluating the value of businesses. Consider utilizing the HAv2.3 framework.

         The Market Cycle: Up  

        "[T]he fact that so many people seem to be making big profits on the investment and telling others about their good fortune, makes the investment seem safe and too good to pass up." [1] 

        "Addicts often have to take heavier doses to get the same thrill as time passes. The same is true in aging bull markets. Companies need to report bigger and bigger earnings to get the same rise out of investors. … [I]nvestors are offering skimpier rewards than they did in the past to companies that beat expectations. … That could turn dangerous if companies are tempted to dig ever deeper to show the next penny of profit. … [A]nalysts and companies dance expectations downward in tandem. Analysts … deliberately lowball their earnings estimates, helping companies to beat them and, over time, boosting the stock price. … To call such predictably engineered numbers 'surprises' is almost absurd. … [E]ven though the game is obviously rigged, investors are still playing along. … The companies aren't doing better than expected, the expectations are artificially low. That makes surprises close to meaningless indicator. … [S]omething may well be fundamentally off at a company that comes up short of expectations. In today's market, that red flag is redder than ever. … [B]ear in mind that late bull markets are breeding grounds for temptation, when companies … often can't beat the habit of trying to beat expectations. In 1999 and 2000, some allegedly cheated to keep doing it." [2]

       "Trustify [Inc.]'s case puts a spotlight on a culture of Silicon Valley in which ultra competitive investors might not ask for hard evidence such as official bank statements from startups when they are rushing to invest in a hot funding round that only allows days or hours to commit to an investment. 'If you feel like you need verification of something and are afraid of asking for it because it will throw you out of the deal or someone will really be offended, maybe it's not the right deal for you,' said Stephen Palley, partner at law firm Anderson Kill, who advises startups and investors. … Most seed-stage startups, as well as many Series A startups, don't have audited financial statements or a chief financial officer given the cost of such measures in the earliest stages of a company, according to several venture investors. Two Trustify investors said that they hadn't seen audited financial statements from Trustify. The investors said they didn't know if the company ever had audited financial statements. This due diligence problem is only exacerbated during a heated venture market that had been setting records for valuations and funding levels before the coronavirus pandemic. 'In an overheated environment everyone wants to get in and people can get sloppy,' Mr. Palley said." [3] "[T]here's often a reverse incentive for investors to do too much digging before writing a check. Ask too many tough questions and they risk losing money on their investments or getting shut out of a current or future funding round." [4]

        "Until recently, many investors believed central banks and other policy makers had repealed the business cycle and that making money in the stock market was something you could take for granted…. Maybe investors a century ago and more had a wiser view. They believed … that financial panics were a form of divine retribution for the sinful excesses of prosperity. … [B]elieving that panics have become obsolete is a precondition for their recurrence. The modern history of financial markets is a chronicle of attempts to control risk—if not eliminate it. One after another, they have all failed. … But risk can't be removed; it can only be moved. The techniques … may have caused [] financial crisis … by making bankers and investors so complacent that they never sufficiently tested whether their assumptions might be wrong. … The early U.S. suffered severe financial panics roughly once every 13 years on average, in 1792, 1819, 1826, 1837, 1857, 1873, 1884, 1893 and 1907. … [O]ptimism leads to a 'flood tide of prosperity,' which washes away caution, creating euphoria that culminates in a crash—which, in turn, clears the way for recovery. … The longer the good times roll, the more remote the chance of a decline will seem, the more overconfident investors will feel and the more risk they will take. … [I]t isn't investments that make or lose money; it is investors, with our own excesses of greed and fear. … Blind faith in tools for controlling financial risk has never made sense. If risk could ever be eliminated, investors would immediately turn so euphoric that they would drive the prices of financial assets sky-high—thereby creating an enormous new risk out of the absence of all the old ones. Investors should never stop trying to manage their risks. But they should never believe that they, or anyone else, can eliminate them." [5]

        "'This time is different' are said to be the four most expensive words in the English language...." [6] "[M]emories can be short, especially in the financial markets. ... People are considering deals they wouldn't have touched 12 or 18 months ago.... In a market that is hot ... they might not do as much due diligence.... That's the risk...." [7]

        "Investors usually dismiss worries about aggressive accounting when they involve a fast-growing company in an exploding sector. Instead, they should wonder why such a company would resort to aggressive accounting in the first place." [8] "Around the start of the millennium, high-flying dot-coms said their companies were worth hundreds of millions based on unusual yardsticks like how many viewers were looking at their websites. … [A]s investors learned in the dot-com bubble, equity valuations can plunge fast. … The alternative valuation metrics of that era, like 'eyeballs,' 'monthly unique visitors' and 'stickiness' looked idiotic by late 2000. …'When the downturn happens, some of those creative interpretations of valuations fall away,' [Mike Terwilliger, portfolio manager at ResourceAlts] said. 'That can get pretty ugly.'" [9] "As long as investors were willing to believe that profits were coming, it all worked—until it didn't. ... [M]ost things that are economically unsustainable, from money-losing dot-coms to subprime mortgages, eventually come to a bitter end." [10]

        What did P. T. Barnum say? "Whenever greed meets reality and giddy markets collapse, Wall Street pros usually admit that they sensed the end was coming. The warning signs were so familiar, they belatedly confess, that it was difficult to believe anyone could miss them. The chain of fools was running out.  … Privately, and increasingly publicly, financial professionals warn this will end badly for the investing public. To cynics, the only questions are when, and how badly. … [A] matrix of hedge funders, private-equity dealmakers, bankers, lawyers and assorted promoters [] see the excesses building. They point to you've got-to-be-joking valuations, questionable disclosures and, most worrisome, a growing misalignment of interests. … The bad omens are all around. … SPACs, also known as blank-check companies … have a lot of wiggle room in valuing the businesses they buy. Unlike traditional IPOs, where financial results are in focus, SPACs can base entire deals on projections." [11] "[A]t a 2021 investment committee meeting of the California Public Employees' Retirement System ... [a]n external advisor warned board members that the boom in blank-check companies was a sign of froth in financial markets." [12] "The SPAC boom cost investors billions. Insiders in the companies that went public were on the other side of the trade. Executives and early investors in companies that went public via special-purpose acquisition companies sold shares … profiting before share prices collapsed. …  Companies that went public this way have lost more than $100 billion in market value. At least 12 have filed for bankruptcy and more than 100 are running low on cash…. Many executives claimed during the boom that SPAC mergers were a better way for companies to go public than traditional initial public offerings." [13] "What made SPACs so special was the 'investor presentation' included in the merger filings after the SPAC found a company to combine with.... Usually toward the tail end there would be a financial projection – often going out years. As it turns out, many (or most) of these companies' grand projections were nothing but fantasy. … [I]f that's the only way a company can go public, you have to wonder why." [14]

        "If you come to crypto because (1) you are very self-confident and (2) you don't know anything about traditional finance and don't want to find out, then you will have a lot of fun repeating and magnifying the historical errors of traditional finance." [15] "[W]e were experiencing a peak in investment absurdity. The examples then were bitcoin, dogecoin and nonfungible tokens (NFTs), as well as meme stocks, the prices of which were not tied to sober reflections about their issuers' business prospects but to internet-fueled speculation. Assets like these, which are priced in accordance with the 'greater fool' theory…. The old saw applies about how if you're looking around the poker table and can't identify the mark, it's you." [16] "The low bids come as the NFT market has slowed in recent months." [17] "Any time there is a boom cycle like this, otherwise smart investors do dumb things because they see their pals and peers piling in and worry they will be left out. Envy is a pernicious quality — and one that is all too human." [18]

        Take a look at what else emerges towards the peak of a bubble. "Over the past two years … financial firms are pile-driving their clients into assets that have no market. … Many of these other corporate offerings instead come directly from tiny issuers or through dodgy brokers and financial advisers. … The investments sometimes end up worthless, and egregious conflicts of interest are rife among those selling them. … The fatal flaw: … often you can't sell at all. … The risk of default or bankruptcy is high. Commissions and other fees can easily exceed 10%." [19] "Alternative investments—assets such as stocks and funds that don't regularly trade in public markets—are one of the biggest fads on Wall Street. Investors being pitched on them should take note: The market for Reg D investments isn't the Wild West, where some rules don't apply. It's closer to anarchy, where rules barely exist and disclosures can be utterly untrustworthy…." [20]

        "Boom times are always accompanied by fraud. As the Victorian journalist Walter Bagehot put it: 'All people are most credulous when they are most happy; and when money has been made . . . there is a happy opportunity for ingenious mendacity.' ...  Bagehot observed, loose business practices will always prevail during boom times. During such periods, the gatekeepers of the financial system—whether bankers, professional investors, accountants, rating agencies or regulators—should be extra vigilant. They are often just the opposite." [21] "It is [] about how people [m]ake decisions. … [C]ognitive shortcuts helped propel [Theranos] to a valuation of more than $9bn, before … it spirall[ed] towards oblivion. One shortcut concerned Ms. [Elizabeth] Holmes herself. … [P]eople too easily equate confidence with competence. …Seasoned executives at large companies lauded Ms. Holmes for 'owning the room', but ignored warning signs that the firm's product did not work. That may have been because of a second decision-making shortcut: many investors and executives relied heavily on the judgments of others rather than their own eyes. … But at some point due diligence has to extend to seeing a technology in action." [22] "The company's glittery board of directors and self-assured pitch by its founder encouraged investors to ignore the multiple red flags waving over Theranos. Trial evidence pointed to numerous investors who put money into Theranos despite being warned away by experts. … How many of the factors that enabled Theranos to raise hundreds of millions of dollars without a workable technology have changed? None. Investors are still looking for the next big thing, still looking for places to park their millions, still susceptible to superficially persuasive pitches by self-assured confidence schemers, still fearful of being left by the wayside as others pile in. That's human nature. The only difference is that the numbers next to the dollar signs are bigger." [23]  "[N]one of the Theranos investors, who invested more than $700 million with Holmes between late 2013 and 2015, had ever requested audited financial statements or asked whether the company even used an outside accountant to verify the financial information that was distributed. …  Such boldface-name investors ... lost their entire investments." [24] John Mills wrote in 1867: "Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works."

        "'Prestigious companies, those that are household names, were actually more prone to engage in financial fraud, which was very surprising,' says lead author Jennifer Schwartz, a sociologist at Washington State University. 'We thought it would be companies that were struggling financially, that were nearing bankruptcy, but it was quite the opposite. It was the companies that thought they should be doing better than they were, the ones with strong growth imperatives—those were the firms that were most likely to cheat.'" [25] "Recklessness with the financial truth is often a sign of an economic bubble about to deflate—see the dot-bombs and Enron in late 2000 and the banks amid the 2007 subprime mortgage crisis. Scandals don't cause recessions, but they can help trigger one." [26] "Regulators are scrutinizing whether companies are manipulating financial results to meet Wall Street targets, as a profit-squeeze amps up pressure on executives to 'make the numbers.' … Tough economic times have historically been fertile ground for earnings management. Executives use flexibility in the accounting treatment of items such as reserves for losses, or revenue recognition, to boost reported earnings per share." [27]

        "[W]hen a company plays sneaky with one number, there's pretty good odds that they're being sneaky about other numbers too." [28] "Get ready for what will feel like an inescapable wave of corporate fraud. With financial conditions tightening, the market is primed to put pressure on corporate balance sheets, tempting executives to cheat to meet Wall Street's expectations. …. [E]xecutives [] think that by committing acts of fraud, they can obfuscate their dire financial situation. … [W]orldCom's bottom line took a hit. To make it look like it was still growing at a healthy rate, executives started pulling accounting tricks — recording expenses as investments and manipulating cash reserves…. [C]orporations commit[ting] securities fraud … may appear to experience a sudden liquidity crisis that is not really so sudden." [29] HAv2.3 recognizes the games.

        "Manipulation of earnings from Corporate America is on the rise, an ominous omen for the U.S. economy. … Unless you study accounting, you have likely never come across the M-Score…. The 'M' is for manipulation, and uses a company's financial statements to determine whether it is engaging in manipulation. Since the 1990s, the metric has been used to identify red flags at individual companies. … The probability of manipulation usually rises rapidly in the quarters before the economy tips into recession. … The new aggregate measure … shows that the collective probability of fraud across major companies is the highest in over 40 years. The M-Score is calculated from eight ratios on a company's balance sheet, all numbers that public companies report…. The theory is that their index might be catching distress in the stages when some companies are taking steps to try to cover it up. That is when conditions on the ground are beginning to deteriorate, but firms are continuing to report strong earnings. The stock market might behave like the corporate sector is still humming along when in reality, its earnings are increasingly buoyed by tricks." [30] "History confirms … that burst bubbles and accounting controversies tend to go hand in hand.  …  Consider past experience. Corporate bankruptcies and unraveling frauds were among the hallmarks of the 1930s, following the crash of 1929. … The root of the accounting problem … is that stock-market bubbles reward aggressive accounting, since it inflates earnings and helps push up companies' stock prices. As bubbles develop and the continued inflation of stock prices becomes paramount, conservative accountants and executives become discredited, and bending the rules becomes standard." [31] HAv2.3 calculates M-Scores and other similar indicators of financial shenanigans.

        "Investors rely on auditors to serve as watchdogs against corporate fraud. But auditors have little to gain—and much to lose—from doing a lot of barking. Although failing to detect fraud can be disastrous, auditors know that identifying genuine wrongdoing usually means considerable trouble and expense--and perhaps questions about why it wasn't spotted sooner. Conversely, a false alarm about fraud antagonizes clients, dismays supervisors and produces its own stresses. Auditors thus learn to be reluctant skeptics." [32] "Wall Street's top watchdog is warning that the market selloff and fears of a recession could encourage more companies to cook their books, and it is pressuring auditors to catch them. … After coming under fire for its role in Wirecard and other corporate failures, [Ernst & Young] two years ago told clients it was taking a number of steps to more actively look for big frauds … The firm is using artificial intelligence to parse ledgers for suspicious transactions, mining social-media posts and using forensic-accounting specialists earlier to look for potential accounting violations at high-risk companies…. … Such measures by EY and other accounting firms don't overcome the basic conflict of interest in the industry: Accounting firms are paid by the companies they audit, making it less likely they will confront bad behavior. Worries that auditors can buckle under client pressure to sign off on suspicious financial statements go back decades. In the run-up to the 2001 collapse of Enron Corp., a partner at its now-defunct auditor Arthur Andersen complained that his advice against certain accounting practices was being ignored. The partner was later removed from the Enron audit team, following complaints by an executive of the Houston-based energy company." [33]

        "The [internal auditors] had run into an inexplicable $2 billion that the company said in public disclosures had been spend on capital expenditures…. Capital costs, such as equipment, property and other major purchases, can be depreciated over long periods of time. In many cases, companies spread those costs over years. Operating costs such as salaries, benefits and rent are subtracted from income on a quarterly basis, and so they have an immediate impact on profits.  … By 2000, WorldCom had started to rely on aggressive accounting to blur the true picture of its badly sagging business. … But by 2001 it wasn't enough to keep the company afloat. … [Mr. David Myers, Worldcom's controller] admitted that he knew the accounting treatment was wrong…. He said that the entries should not have been made, but that once it had started, it was hard to stop. … [W]orldCom stunned Wall Street with an announcement that it had inflated profits by $3.8 billion…." [34]

       "[W]e are living in 'a post-truth environment.' That translates, [Jim Chanos founder of hedge fund Kynikos Associates] argues, into a mood in which investors are also willing to suspend disbelief. … 'There's a very clear link between great episodes of fraud and the financial cycle. When we've had great frauds, they’ve always been at the tail end of great financial cycles,' says Chanos…. [I]t's then easier for fraudsters to raise money, and generally they're not exposed until the cycle turns down because then people stop funding them and want their money back,' he explains. … 'People end up getting more enthralled with the story than they are with the numbers,' [Dan David, the co-founder of GeoInvesting] says. 'That's a mistake.'" [35]

       "The financial use of 'bubble' originated centuries ago to describe massive speculation that inflates market prices to the bursting point. … [T]hey are diabolically difficult to identify without the benefit of hindsight. …Financial markets, however, can easily heat up fivefold or even 10-fold and then collapse at least 50% in a flash, burning millions of speculators and sometimes charring entire economies. … When prices go up, more people buy, inflaming prices even more and attracting another rush of speculators. That lures in naive buyers who think making money is easy. But hedge funds and other institutions also chase those hot returns, fanning the flames even higher. …  Marketability, credit and speculation are necessary, but not sufficient, to start and maintain a market fire. A fourth component … call[ed] a 'spark,' is also needed. That can come from new technology, government intervention or both. … [M]ost bubbles tend to be confined to a few stocks or industries." [36] A "spark" assures some that "this time, it's different."

       "The only way to argue that stocks aren't wildly expensive is to say that something fundamental has changed about the market environment. … [I]nvestors could pay a heavy price if they turn out to be wrong. …  [S]tandard measures show valuations are at rarely-seen levels that have typically ended in tears. … [E]mbracing new paradigms can get investors into trouble." [37]

       "Bubbles are perhaps unavoidable; some people will extrapolate too far." [38] "[T]he most enthusiastic buyers in market bubbles often believe they'll stick around to capture even bigger payoffs in the distant future. Bubbles form when catchy stories and the human need for imitation and conformity turn investing into a social imperative." [39]

       "Spotting asset bubbles is hard because there is almost always a good underlying reason for what's going on. Canals, railways and the internet really were going to revolutionize the economy. The mistake with bubbles is that prices disconnect from what the new development will justify. The difficulty for those of us trying to spot bubbles is to tell how much is really justified, and how big the disconnect will become. …  As usual, the question is how high is too high. … One of the characteristics of bubbles is that hope of profit encourages exuberant optimism, and investors hand over money for projects they'd never consider in normal times. … The last boom peaked in 2007 along with the stock market, and might have been a sign of investors having a get-rich-quick mind-set. … [T]oo much money is already chasing too few good-quality deals." [40] "'These things can go further than anyone would expect because they tend to be self-reinforcing' Mr. [Chief Investment Officer of Cambria Investment Management Meb] Faber said. ... One possible sign of a bubble is a belief that negative developments are somewhat positive." [41] "[D]roves of newcomers rushed to trade stocks based on message-board rumors." [42]"Frenetic trading in stocks and options of no apparent worth has erupted anew, a classic sign of speculation that often coincides with tops in the market. … More scary is the opprobrium heaped on GameStop's detractors, who have been objects of online attacks." [43] "Most days, [Kevin Paffrath] live-streams on the platform for several hours, talking about the stock market and doling out investing advice in a rapid-fire, self-deprecating manner. … Many of these influencers have no formal training as financial advisers and no background in professional investing, leading them to pick stocks based on the whims of popular opinion or to dispense money-losing advice. … Still, the online model is entirely new, with influencers judged on the content they produce, rather than their investing track records; and they often get paid based on numbers of subscribers and viewers, rather on the investment income their advice generates for clients. …  Many influencers report that when they hype an investment, they get the page views they crave. When the message is bearish, however, viewers turn away, or worse, attack the messenger with vicious trolling. … The real danger in the social-media finance world, he says, is that younger influencers tend to believe the market only goes up." [44] "Venerable institutions … have employees combing through [] internet forum[s] … in search of trading opportunities. They turned to these sources following a period of market mayhem dominated by amateurs…." [45]

       "You can never predict when a bubble will actually burst. Some of them can continue for a remarkably long time. But when they do, they almost always do so quickly and dramatically." [46] "At one point, the most coveted Beanie Babies, which sold for about $5 in the store, were worth about $5,000." [47] "What goes up often keeps rising. That's the logic at the heart of momentum investing—a strategy that's been surging lately. ... What's more, some investing pros say we've entered an era well suited to momentum strategies—where one asset after another experiences a bubble that then bursts. ... These momentum trends in markets have more to do with the faddishness of human behavior than the fundamentals of economics and balance sheets. In essence, investors often flock to the stocks that have been going up, which tends to propel them further. Momentum ... traders don't analyze why ... stocks ... are on a winning streak recently or determine whether the stocks are expensive or cheap in theory. Momentum seekers jump on the bandwagon, intending to jump off again before the inevitable train wreck that ends the journey. With so many traders watching the same charts and seeing the same signals, these trends often become ... a self-fulfilling prophecy. ... [I]nvestors get excited because momentum beats the market on the way up—and often forget that it gets hammered more than the market on the way down." [48] "What a week for crypto enthusiasts! …Much of Bitcoin's rise may just be driven by FOMO [an acronym for 'fear of missing out']. … A survey by the U.K. Financial Conduct Authority found that 76% of young people investing in high-risk products felt a sense of competitiveness with friends, family and other acquaintances, making the cryptocurrency look more like a machine for YOLO [an acronym for 'you only live once.' It is a call to live life to its fullest extent, even embracing behavior which carries inherent risk] trades rather than a reliable store of value. [49] "Cryptocurrency- related job postings in the U.S. surged 395% between 2020 and 2021 … dramatically outpac[ing] the wider tech industry…. The most common crypto job postings were blockchain developer and engineer…. This jobs boom comes as investments are pouring into the industry. Venture capitalists invested a record $30 billion in crypto companies in 2021…. And in another sign of the times, Los Angeles has renamed its iconic Staples Center the Crypto.com Arena." [50] "[C]ryptocurrencies, with their huge price fluctuations seemingly unrelated to fundamentals, are about as risky as an asset class can get. … Maybe the rising valuation (although not use) of Bitcoin and its rivals represents something more than a bubble, in which people buy an asset simply because other people have made money off that asset in the past." [51] "There is something unseemly … about the famous and fabulously wealthy urging crypto on their fans. Cryptocurrencies, after all, are in many cases not so much currencies as speculative thingamabobs - digital tokens whose value is predicated largely on the idea that someone will take them off your hands at a higher price than it cost you to acquire them. … The cryptocurrency industry's marketing efforts are focused on young people, especially young men. … [T]hey amount to a macho taunt: If you're a real man, you'll buy crypto. …  [C]ulture has taken a sinister turn: that we've sanctioned an economy in which tech start-ups compete, in broad daylight to lure the vulnerable with get-rich-quick schemes." [52]  

          "When a public company is in dire financial straits – with too much debt, not enough cash and financial metrics going the wrong direction – there's usually an effort to get the banks or other lenders and/or big investors to figure out a way to work things out. If things are really bad, that typically involves issuing new debt to replace the old debt… and doing such things as granting waivers on debt covenants to give the company one last chance to avoid having to wear the scarlet 'B'. … [T]hese stocks are almost always of companies behind a popular brand, product or concept or former high-flyer… the very kind of companies that are like magnets to the 'meme' stock crowd. … [A] key attraction is the ability to squeeze heavily shorted stocks higher. That means buying them for no other reason of forcing short sellers to cover at higher prices, creating a self-fulfilling momentum driven feeding frenzy. … But for most investors, it's the same old 'fear of missing out' (FOMO) trap… that if they don’t get in they'll miss out on the next big home run, which for some reason always happens to involve a company on the verge of going out of business. … None of that really matters because these investors – almost naively – are playing straight into the hands of investment bankers behind this ingenious strategy…. [W]hat goes up on hot air, plunges when it's gone…." [53]

          "In a market bubble, it's easy to confuse opportunity for genius. … [I]t's no surprise that some of the loudest voices from the market's precipitous rise have gone silent. … Let their silence be a lesson. When financial markets are minting not just money but celebrities, it's time to be more than skeptical. It's time to prepare for the kind of disaster that makes once great stock pickers look like pikers. … The most popular notion of our last rally was a bet that economic conditions would remain favorable to companies that didn't make money — that these firms could grow off debt and investment capital alone. … The market seemed so friendly that influencers realized they could get average investors in on this action too. … When people are making money in the market on some new fad or asset, it can be hard to not jump on board. But if that buzzy money-making investment sounds too good to be true, it probably is. And if it sounds too stupid to be true, it's probably even stupider than you think. … It's really never a good sign when you see celebrities hanging around the stock market, and during the bubble they were everywhere…. Their main message is that it's not hard to make money — in fact, you'll miss out if you don't get involved. It is a siren song for gullible people. Good information about the stock market does not come easy, and Gordon Gekko was right to say that if you want a friend on Wall Street, you should buy a dog. If anyone tries to make you feel like you're just as smart as the professionals, they're trying to take your money." [54]

       "[T]he bubble pops when everybody has concluded that what has gone on with prices make sense. ... [T]here isn't much of a step between believing that a bubble will continue and believing that not participating in the bubble will amount to lost opportunity." [55] "A bubble occurs when exaggerated expectations of future price increases generate unusual demand either by people who fear being price out of the market or by investors hoping to make a lot of money fast. A bubble is a self-fulfilling prophecy for a while, as successive rounds of buyers push prices higher and higher. But the willingness to continue to pay higher and higher prices is fragile: It will end whenever buyers perceive that prices are no longer going up. Hence, bubbles carry the seeds of their own destruction. Only time is needed for the bubbles to end." [56] "[O]nce a crisis of confidence gets going, it can be impossible to control. ... [I]t's easy to be wise after the event, whereas wisdom before the event is apparently impossible. ... [F]inancial confidence is always more fragile than it looks, and [] worst-case scenarios have an infuriating habit of coming true." [57]

        Whether fake news or not, this article has to signal the top of an overheated financial market. "A reality TV star who launched a gassy venture peddling her fancy flatulence to strangers Stephanie Matto, 31, blew away people on social media when she recently announced that she makes more than $50,000 a week selling her farts. … But after making $200,000 in sales, the influencer has announced her retirement when she passed one too many and got the wind knocked out of her…. Matto was rushed to a hospital with chest pains she feared were symptoms of a heart attack…. After undergoing a battery of tests, including blood work and an EKG, Matto was told that her pain was the result of her steady diet of gas-inducing beans and eggs. … The newly retired fart peddler said she plans to donate a portion of her income to charity that supports gastric disorders." [58]

        "When things start to go wrong, they get worse than anyone ever imagined they could. ... Regulators should ask the dozen or so top financial services firms ... what their most recent crop of top business school hires are working on—not just their general assignments but precisely what they're doing. ...  [C]rises follow the talent with a lag of about three years." [59] "Several top schools have added or rushing to add classes about Bitcoin and the record-keeping technology that it introduced, know as the blockchain." [60] "Baruch [College's master's financial engineering program] teaches students skills like data science and financial modeling. … Funds have been recruiting the kind of people who can make investment decisions using code, big data and machine learning. Two of the Baruch graduates working at hedge funds reported a compensation of $1 million or more." [61] If the reports are true and if those reporting believe in their continuing abilities to generate humongous profits, they could set up their own shops and not answer to and share with others. 

         "So what does all this mean to us as investors? In a speculative environment, just about the only ones who profit are short-term traders. ... If you want to bail out, you have to do so on the way up and not worry about missing the peak." [62]  However, learning and doing financial statement analysis is not easy, but the effort is worth it—it keeps your investment decisions rational.

        The Market Cycle: Down 

        "So what precipitates a crash? It's not just price—it's speculation, volatility, stock issuance, accelerated price increases and a disproportionate rise in prices among newer firms." [63] "[A] series of manias [] have gripped the financial world. For months, professional and everyday investors have pushed up the prices of stocks and real estate. Now the frenzy has spilled over into the riskiest—and in some cases, wackiest—assets, including digital ephemera and media, cryptocurrencies, collectibles like trading cards and even sneakers.  … So many got creative and … took on more risk.  … That has now led to mini-bubbles…. [S]tocks … became even more expensive. That was when more people started investing in nontraditional assets. … Predicting when and how the party will end is anyone's guess. … [A] Roaring Twenties-style era of prosperity … decade ended in a devastating crash, [but] the euphoria lasted years." [64]

        "[M]any who saw the bubble inflating [Panic of 1837] warned about it bursting, including journalists.... People will over-lend and over-borrow until the day of reckoning. ... It's just the way we are." [65]

        "'When people are stressed their reason is hampered, so they look at what other people are doing. … [I]t leads you to engage in the same behavior,' [Sander van der Linden, an assistant professor of social psychology at Cambridge University] said." [66]

       The Opportunity        

        "[A] crisis is not just a bad situation. ... The Chinese have a similar concept: The characters for crisis (危机) combine parts of those for danger (危险) and opportunity (机会). A crisis is a point when people have to make rapid choices under extreme pressure.... A crisis is certainly a test of character. It can be scary. ... Students of crises are fond of dividing them into phases. For example, Charles Kindleberger's 'Manias, Panics, and Crashes: A History of Financial Crises' identifies five phases of a financial crisis: an exogenous, normally positive, shock to the system; a bubble in which people exaggerate the benefits of that shock; distress when some investors realize that the game cannot last; the crash; and finally a depression. ... The bubble is typically characterized by mania and denial. Things are going well—or, at least, appear to be. Feedback loops end up magnifying confidence. ... In finance, leverage plays a big part. ... Manic individuals ... end up taking excessive risks.... But before that, there is denial. People do not wish to recognize that there is a fundamental sickness in a system, especially when they are doing so well. ... Market participants had such a strong interest in keeping the game going that they turned a blind eye to the unsustainable buildup of leverage. ... It is hard to recognize a sickness, given that there is usually some ideology that explains away the mania as a new normal. The few naysayers can be ridiculed by those who benefit from the continuation of the status quo. ... The crash, by contrast, is characterized by panic and scapegoating. People fear that the system could collapse. Negative feedback loops are in operation: The loss of confidence breeds further losses in confidence. ... Events move extremely fast, and decisions have to be made rapidly. ... [¶] In this phase, no one denies that there is a problem. But there is often no agreement over what has gone wrong. Protagonists are reluctant to accept their share of the responsibility but instead seek to blame others. Such scapegoating, though, prevents people from reforming a system fundamentally so that similar crises do not recur. Crises will always be a feature of life." [1]

        "What does it mean when investment professionals say, 'Buy the panic'? . . . Buying stocks during a market panic sounds easy to do when you look at history. Still, it's much harder in practice. ... If investors wait for the market to rally again before investing, then they are giving up on potential profits. But if they act too early when making stock purchases, then they may incur even more losses. Investors can conquer that problem by making measured purchases depending on how confident they are about where the market is moving. ... However, the largest hurdle when investing during a panic is that the best time to do so is when you will likely be least willing…. It's the moment of maximum fear, which will also coincide with the peak in panic." [2]

        "True contrarians only buy stock when it makes them feel physically sick. ... Even if you successfully picked the bottom, would you have held ... ? ... But even with perfect hindsight there were plenty of great reasons to sell along the way. ... [W]ould you be able to ignore the temptation to lock in profit?" [3] "[I]t's easy to say you'd buy more stocks if the market fell 10%, 20% or more. In a real market crash, it's a lot harder to step up and buy when every stock price is turning blood-red, pundits are shrieking about Armageddon and your family is begging you not to throw more money into the flames. Then risk is no longer a notion; it's an emotion. … The best guide to whether you will dump stocks in the next financial crisis is whether you did in the last one. If you weren't investing in 2008-09, look back at the fourth quarter of 2018, when stocks lost nearly 20%." [4] "In a severe bear market, you're often trading with someone who has to get out or go broke so you may have the advantage."  [5]

        "It's the time to buy for investors able to stomach the market's swoons. … Mom-and-pop investors have largely been sitting out—a sign that the rally doesn't reflect widespread optimism. … Paradoxically, some of the most skeptical investors—short-sellers, who make their money betting that shares will fall—have contributed to the rally. Short-sellers borrow shares and immediately sell them in the hope that they can buy them back later at a lower price and pocket the difference. But when the market goes against them and share prices rise, short-sellers can face disastrous losses if they don't quickly buy back the shares and return them to their lender. Retail shares have bounced back in April, most likely driven by short-sellers rushing to cover their bets. Nordstrom and Macy's—both up more than 20 percent this month—were top targets of short-sellers in recent weeks, according to S3 Partners, which tracks the activity of short-selling. … And don't underestimate the fear of missing out. As shares rise, professional money managers feel pressure to buy stocks to protect their reputations. … Concerns over so-called career risk can overwhelm fundamental analysis of stocks and bonds, forcing a headlong rush into markets even if a buyer doubts the rally can last." [6]

        "Warren Buffett famously said he tries to be fearful when others are greedy and greedy when others are fearful.  For some money managers, that isn't just clever advice—it is an entire investing strategy. The idea of embracing out-of-favor stocks, sometimes called contrarian investing, isn't new. But the approach requires a strong stomach in the best markets, let alone during historic downturns." [7] "[C]ontrarian thinking is only helpful at extraordinary inflection points in the market.... Most people think that contrarian investing means doing the opposite of what others are doing. But going against the crowd is a surefire way of getting trampled. The majority of investors are usually right. True contrarians look for points of maximum exuberance or despair, which is when the majority is generally wrong. ... The way you can tell most investors who go against the herd is from the hoof marks on their backs." [8] "The trick for contrarians … [is] to avoid being contrary all the time. … At turning points … the herd [i]s nearly always wrong. … [L]ook[] for 'crescendos of euphoria and pessimism'…. Opportunities ar[i]se when 'something has changed for the better but the market has not yet recognized it' … and when 'nothing has changed but the market has given too much emphasis to the negatives.' … 'A lawyer is trained to assemble as many of the available facts as possible before making a decision … whereas a portfolio manager can gain a competitive edge if he is able to make a sound decision before all of the pieces of the jigsaw puzzle are in place.'" [9]

        "Meanwhile, company insiders appear to be buying. According to AlphaSense, a data platform, regulatory filings announcing purchases by executives and directors have jumped in recent weeks. … • At companies with market caps of at least $1 billion, there have been 1,305 filings for stock purchases so far this month, compared with just 113 during the same period last year. Executives may think the bear market has hit their shares too hard, or that purchases with their own money serve as a sign of commitment during tough times — or a bit of both. [10]

        "Everyone thinks they're a genius in a bull market, but it's only when prices head south that some people really stand out from the crowd. ... Knowing how to handle fearful times like these offer the best opportunity to avoid lagging behind the market. … Investor psychology in a major bear market is a mirror image of what it was the past few years: The more false alarms there were on the way up, the likelier investors were to embrace risk, viewing dips as buying opportunities. On the way down, so-called suckers' rallies—and the technical bull market we reached on Thursday may well have been one—get our hopes up and then crush them. By the time a really prolonged bear market is about to end, investors who haven't sold in disgust probably have a lower percentage of their net worth in stocks than at the outset. That is one of the costliest mistakes investors make. A surprising share of a new bull market's returns pile up in its very early stages when people are most fearful. … Making lemonade out of the market's lemons sounds tempting, but it isn't easy. The old saw goes that the stock market is the only one where people run away when there's a sale. Beforehand they crowd in when the wares are most expensive because they see everyone else getting rich." [11]

        "[]During economic down cycles when everyone's more pessimistic, investors turn to deep-value stocks, meaning stocks with relatively low valuations but with good cash flows and dividend payouts… [] … The debate between value investors and growth investors goes back at least a century, and appears to be explained in part by genetic predispositions. Some investors prefer the safety of companies that have reliable earnings, plenty of cash and stable business models; others get excited about finding tomorrow's success stories today. The risk for investors who favor cheap stocks is 'the value trap,' a term for stocks that look too cheap to ignore—but stay that way even after you buy them." [12]

        "Most investors 'almost reflexively described themselves as value investors....' ... No sane person wants to overpay for stocks." [13] "The cardinal distinction between a share's price and its value goes back to Benjamin Graham, the father of value investing. Price is a creature of the market's mood, he wrote. In booms, it is set by the greediest buyer; in busts by the most fearful seller. A stock's value, in contrast, is enduring. It is anchored by the worth of a firm's assets. The enterprising investor can profit from finding stocks that sell for much less than their value, said Graham. There have since been countless studies showing that value stocks do better than 'growth' stocks, their antithesis, over the long haul. … Frumpy value stock gets left behind—until sanity returns. … This agonizing is not for most people, says James Montier, of GMO, a fund-management firm: 'They don't want to be wrong for as long as it takes.' Value investors hope to be rewarded for being so out of step with everyone else for so much of the time. But a select few can endure—and even enjoy—it." [14]

        "Prof. Eugene Fama, who won an economics Nobel Prize, argued that value stocks outperformed because they were riskier, and the efficient stock market rewards higher risk in the long run. A different view holds that investor behavior is the answer: investors shun bad companies more than they should, leaving them artificially cheap. Those with the gumption to buy will eventually be rewarded when others recognize that their prospects are merely bad, not awful." [15]

        "Historically, value-style investing has performed in fits and starts—typically lagging behind growth for extended periods but ultimately winning the race, at least for investors who don't drop out before the finish line. … Value investing isn't as simple as finding great companies trading at attractive prices. There are many theories for why value has underperformed. The easiest one to grasp: Legitimate bargains abound early in a market cycle, but eventually value stocks get picked over. If something is cheap in the later stages of a bull market, it's usually for good reason." [16] "Small-cap stocks ... typically rise ahead of a wider market rally and fall ahead of a broader market capitulation. ... Contrarian investors see a buying opportunity in the recent rout." [17]

        "[F]ewer investors analyze one value stock at a time by hand. Often, they use computers to buy the value 'factor' en masse, capturing cheapness as a common attribute across hundreds of stocks at once. That has lower costs for investors. But it has also driven up prices, reducing the supply of bargains among value stocks...." [18]

         "[T]he higher long-run return from investing in cheaper stocks is a righteous form of payback for the pain of sitting around for years watching all those growth stocks with piddling profits go straight up. If you do not have a vast reservoir of patience and you can't ignore the better short-term fortune of other investors, you won't be able to stomach value investing long enough to benefit from it." [19]

         Sometimes, a "value" fund is wolf in sheep's clothing. "Zoom was priced at 690 times the company's earnings over the past 12 months and 203 times what analysts are guessing it will earn in the next 12. Among the institutional buyers were three dozen 'value investors,' whose mission is to find the cheapest stocks. … Those are tiny stakes. But that might be the point. …  Small bets on scorching-hot stocks make sense for many fund managers. If they bet wrong, their returns won't suffer much. If they bet right, the payoff on even tiny bets, can add significantly to a fund's overall return." [20] "In college, Benjamin Stein and Zachary Sternberg devoured Warren Buffett's annual letters, embracing his value-driven approach to investing. This guided the undergrads when they started a hedge fund…. Around 2017, Stein and Sternberg began to change tack, going on to place what would become chunky wagers on highflying growth stocks and lengthening how long they were willing to wait for those companies to generate profits. The shift worked—for a while. … The New York hedge fund lost about two-thirds of its clients' money in 2022…. But in markets, venturing afield is often risky. … In college … Sternberg studied accounting. … The pair later vowed to return to prioritizing companies that were consistently profitable and carried little debt." (WSJ, 12/20/23, "A Wunderkind Hedge Fund Strayed Beyond Value Investing….")

         Persons "who do independent credit analysis usually do it to find undervalued instruments that represent investment opportunities...." [1]

         "4. Wall Street analysts don't 'do' complex. Isn't that what securities analysts are for, you might ask?  Silly reader . . . analysis is for kids! Literally. At most large Wall Street firms, the tedious job of constructing financial models and answering client accounting queries is handled by the junior analyst on the team. It still shocks me today that when meeting with a team of 'sell-side' Wall Street analysts from a firm to discuss a particular company, the senior analyst invariably concedes the answer to a complex financial question to a junior analyst working for him. ... Senior analysts still spend most of their time on the road making client presentations. That is, of course, if they aren't playing golf with the CEO or organizing the menu at the next investor conference in Las Vegas. The recent attempts by certain companies to discourage hard-hitting independent research will only serve to maintain the chasm between those that 'do the numbers' and those with, hopefully, the experience to know what the numbers mean." [2]

         "[T]he lessons [Herb Greenberg] have learned can be boiled down to five that are remarkably obvious and simple but are still often ignored in the heat of battle: Lesson No. 1: The numbers don't lie. ... That is why some ... analysts don't like to talk to companies. They want to avoid the spin or the face-to-face meeting that can create a psychological connection that may skew what otherwise would be black-and-white analysis. ... Lesson No. 2: Quality, not quantity. Ignore the 'beat the Street' headlines on earnings. It is what goes into the earnings that counts. ...[T]he real story is often on the balance sheet. And let's not forget the cash-flow statement. ... The more complex and convoluted the financial statements get, especially for businesses that aren't overly complicated, the more reason to worry. Lesson No. 3: GAAP isn't the same as a Good Housekeeping seal. Generally Accepted Accounting Principles ... include plenty of gray areas that give management enough rope to hang themselves, if they so please. GAAP, after all, is subject to interpretation, and some managers are more conservative than others. ... Lesson No. 4: Don't confuse stocks and companies. They sometimes go in opposite directions. Stocks sometimes really do lie. Sometimes they are pushed artificially higher by a rotation by investors from one industry group to another... (or) short squeezes.... [S]ometimes they lie because of momentum. Momentum can take stocks to infinity and beyond, but ... reverse momentum ... tends to kick in when you least expect." [3]

         "Outright fraud aside, if securities analysts rely solely on 'the number' (a.k.a. earnings per share), and a cursory glance at the old annual report to make their decisions, they deserve to get burned. Abraham Briloff, professor emeritus of accounting at Baruch College in the City University of New York and the remaining conscience of the public accountancy world, once wisely said, 'Corporate financial statements are like bikinis ... what they show is very interesting; but what they hide is vital.'  You would think that given the historical reputation of Wall Street as a locker room with pinstripes, this statement alone would be enough to induce thousands of hard-working professionals to tirelessly dig deeply into financial statements. But over the latter part of the 20th century, the investment management 'industry' has de-emphasized traditional securities analysis in favor of portfolio analysis, primarily for two reasons. The first is the hegemony of Modern Portfolio Theory (MPT), which … shifts emphasis away from individual security analysis to the analysis of the portfolio as a whole. … The second reason why securities analysis has been de-emphasized has been the growth in the sheer asset size of the investment management industry. Peter Lynch aside, very, very few people can claim competence in managing tens of billions of dollars in portfolios composed of hundreds of stocks. It is simply impossible for even the best and the brightest to engage in reasonably deep fundamental analysis on a 300-stock portfolio. ... What has taken the place of detailed fundamental analysis over the years is the wholesale adoption of earnings per share as the sole basis for securities analysis. … Intelligent and constructive securities analysis has always been the painstaking construction of a mosaic of factors…. The apparent solution to our seemingly collective inability to 'get it,' is to call for more disclosure in financial statements. What is ironic is that if many investors have gotten themselves into a financial mess because they never bothered to carefully read financial statements, then I can almost certainly say that they are not going to read the colossal piles of paper being thrown at them now. … Crooks and frauds aside, we have generally gotten enough from GAAP disclosure to do our work. If we truly shake our heads and can't make heads or tails of a complicated set of statements, we pass and move on." [4]

        "Howard M. Schilit, an accounting expert who runs the Center for Financial Research and Analysis, an independent research firm, scoffed at the excuse that analysts could not have detected problems at Enron. 'Everybody is saying, "they hid from us," he said, but beginning in March 2000, he added, there were a string of warning signs in Enron's public securities filings. The problem, Mr. Schilit said, is that analysts who question the value of a popular company are branded as controversial. 'If you want to move up the hierarchy of the Wall Street establishment, you don't rock the boat,' he said." [5] "John C. Hueston, a well-regarded—and aggressive—prosecutor from Southern California … advocated charging Mr. [Kenneth] Lay with making false statements….  [Hueston] interviewed securities analysts, seeking to understand what Mr. Lay had conveyed to the marketplace. He was shocked to find that most of them had not bothered to look closely at Enron's securities filings and were taking Enron's statements 'virtually at face value.'" [6] "Securities Analysts' Recommendations: Based on available historical securities analyst information we were able to identify, as of October 18, 2001, 15 firms rated Enron a buy—12 of the 15 considered the stock a strong buy. Even as late as November 8, 2001, the date of Enron's disclosure that nearly 5 years of earnings would have to be recalculated, although most firms downgraded their ratings, 11 of 15 continued to recommend buying the stock, 3 recommended holding, and only 1 recommended selling. In November 2001, one firm upgraded its recommendation from sell to hold." [7] "Beginning in January 2001, we spoke with a number of analysts at various Wall Street firms to discuss Enron and its valuation. We were struck by how many of them conceded that there was no way to analyze Enron, but that investing in Enron was instead a 'trust me' story. One analyst, while admitting that Enron was a 'black box' regarding profits, said that, as long as Enron delivered, who was he to argue." [8]