Sober reform and intoxicating profits
It’s about time investors had some real protection against fraud, says this U.S. advisory, which also recommends a firm with plenty of spirits.
Some people think the markets don’t need to be regulated at all.
But don’t count one well-known U.S. advisory in that camp.
“If anything positive came out of the past two years, it’s that the crisis exposed huge gaps in our financial regulatory framework and clearly showed that investors require greater protections,” says Mr. Benjamin Shepherd.
Mr. Shepherd currently holds the editor’s chair at Louis Rukeyser’s Wall Street as a successor to the late Mr. Rukeyser.
This editor’s main worry is that laws set up to protect investors from fraud have had their teeth pulled in the past. Large loopholes and lax enforcement have left the average investor out in the cold.
It’s time to clamp down, he says. How can investors make informed decisions if they don’t have the right information?
This is an American story, of course, based on the actions of the U.S. Congress. But the impetus for reform is scarcely confined to one country (and what happens in Washington is certainly not without meaning to Canadians investing in U.S. stocks).
Following the agitation for reform, we’ll head straight for the bar and sample a consumer stock that spreads its spirits around the world.
Asleep at the switch
Just over a month ago, the House Financial Services Committee approved the Investor Protection Act (IPA).
One of its most important provisions is to beef up the enforcement authority of the Securities and Exchange Commission (SEC), which was famously asleep at the switch during the Bernie Madoff scandal.
It would also impose fiduciary duty on those in the industry who act in advisory roles, including broker-dealers. Essentially, this means that their personal interests must not conflict with their duties to their clients.
The legislation also allows the SEC to nullify mandatory arbitration clauses in customer contracts, and close some of the many loopholes in existing legislation aimed at protecting investors.
“Although most would agree that it shouldn’t have taken a financial crisis to bring about these changes,” Mr. Shepherd writes, “the majority of Americans probably don’t realize the true cost of reform. And it’s not a cost in dollars and cents, but in term of other protections that might evaporate in exchange for these concessions.”
Remember Enron
Just remember Enron, says the editor. After that scandal broke in 2002, the legislation known as Sarbanes-Oxley closed loopholes and tightened enforcement to ensure that internal controls put in place to prevent fraud actually worked.
Yet seven years later, “the meat and potatoes” of that law — the provision that requires companies to report on their internal controls — has not been fully enforced. Under the guise of protecting smaller companies, Mr. Shepherd informs us, firms with market caps of less than $75 million have been “exempted repeatedly from compliance.”
An amendment to the IPA will make that exemption permanent and may ultimately allow companies with a market cap under $250 million to ignore the reporting provision altogether.
This might have been palatable if it were not for another bill in the works, the Resolution Authority for Large, Interconnected Financial Companies, which would encourage the Federal Deposit Insurance Corp (FDIC) to make loans to failed institutions, purchase their debts or assume or guarantee their bonds.
In short, this would essentially cast in stone the “too-big-to-fail” concept. No matter how many missteps banks might make, they could go on taking outlandish risks without having to face the music. They could always count on a bailout.
Not so the investor who is the victim of faulty controls. “An improved regulatory system is all well and good,” concludes Mr. Shepherd, “but it should do more than pay lip service to investor protection.”
When the economy tanks
It’s enough to send many investors for a stiff drink. But is it true that consumers “are apt to get tanked when the economy tanks”? If so, an investment in the world’s largest purveyor of alcoholic beverages might be a good buy for the foreseeable future.
Based in London, Diageo (NYSE-DEO) sells many of the world’s most famous brands of spirits — Guinness, Johnnie Walker, Captain Morgan, Baileys Irish Cream, J&B scotch and more.
Writing for the advisory, Mr. Peter Staas tells us “these well-established names carry a reputation for quality that lends a degree of stability in difficult times.”
That did not prevent it from having so-so results in fiscal 2009. But the long-term prospects are good, in both developed and developing markets. Diageo posted flat sales in North America and increased them by 2 per cent in Great Britain last year, no mean feat when consumers were trading down in many areas.
In the U.S., Diageo is two times the size of its nearest competitor. Overseas, sales are growing in new markets “where consumption of these brands is often associated with Western sophistication,” says Mr. Staas.
While investors wait for further growth in Asia, Africa and Latin America, they can collect a dividend that is supported by ample cash flow and very little debt. The stock trades at $69.63, close to its 52-week high, and yields 4.2 per cent on a dividend of $2.89.
We also have a follow-up on a stock this advisory recommended last month (see text, November 3). Schlumberger Ltd. (NYSE-SLB), the world’s biggest oilfield services firm, was trading at $63 then. The stock is down a bit to $61.70 today. It yields 1.4 per cent on a dividend of $0.84. The advisory’s editorial staff likes the stock’s long-term prospects, and it remains a consensus pick for growth.
In the meantime, this advisory would like to see greater consensus among the powers-that-be when it comes to giving individual investors a fair shake in the market.
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