Enron scandal holds lessons for investors
Enron collapsed nearly five years ago, but investors should pay attention to its trial. By some measures, Enron was the seventh-largest company in the country, and it imploded in a matter of months, taking with it more than $60 billion of investor wealth.
At the beginning of 2001, investors were looking at a company that was a darling of Wall Street, with dynamic leaders who appeared to be revolutionizing the energy and trading markets. Revenue and earnings growth were consistent and stunning.
Hindsight and previously hidden information now expose the sad truth behind the astonishing revenue growth and mysteriously disappearing debt. Hyperaggressive accounting generated the massive revenue growth. To make its debt “disappear,” Enron set up now-infamous third-party partnerships, funded by outside investors who received Enron stock as collateral. Enron would sell nonperforming (i.e., debt-laden) assets to the third-party partnerships, get the cash from the investors, record the cash received as earnings, and no longer show (i.e., hide) the debt. Unfortunately, the debt wasn’t gone – it was in the partnerships, and Enron was guaranteeing a return to the investors in those partnerships with Enron stock. The scheme worked while Enron stock was going up, but when the stock went down, the magic bus went over the cliff.
The Enron case is an extreme example of just how malleable accounting can be, and of what can pass the scrutiny of corporate lawyers and accountants. Here are a few simple questions that might have helped investors lose less money on Enron:
•How does the company make money?
•Does the company provide clear financial statements? (Enron didn’t. Companies should make it easy for you to know what’s going on.)
•Is management forthcoming when asked about the company’s financial condition? (When Jeffrey Skilling was asked why the financial statements did not include a balance sheet or cash flow statement, he responded with a profanity.)
•Are the rats leaving what might be a sinking ship? (Skilling quit in August 2001 and promptly sold all of his shares. Young, driven guys near the top of successful companies don’t often call it quits.)
Ask the Fool
Q: Are 401(k) plans worth using? – P.W., Las Vegas
A: Most major employers today offer retirement plans to their workers, usually in the form of a 401(k) plan. Through it, your employer plunks down the portion of your salary that you specify into the plan, in the form of pre-tax income. So if you earn $40,000 per year and manage to sock $6,000 away into your 401(k), you’ll have only $34,000 in taxable income to report. Your taxes will be lower, and you’ll have some pre-tax dollars invested for the future. All pre-tax contributions grow untouched by taxes until you withdraw them in retirement, as you must generally do beginning at age 70 1/2. At that time, they’re taxed at your ordinary income rate. Money in a 401(k) can usually be invested in a variety of vehicles. We recommend broad market stock index funds, such as one based on the S&P 500. If your plan doesn’t offer one, ask your administrator to add it.
Best of all, many employers match at least a portion of your 401(k) contributions. If yours does, take advantage of it – it’s free money! Learn more about 401(k)s at www.401khelpcenter.com.
Also consider Roth IRAs. They permit you to invest post-tax money and ultimately withdraw it tax-free. And you can invest in a wider range of securities, such as individual stocks.
Q: I want to learn to invest online, but I know nothing about stocks. What should I read? – K.W., Montgomery, Ala.
A: First, don’t invest in anything until you’re comfortable with what you’re doing. Investing books by Peter Lynch are great for beginners, as are the www.betterinvesting.org and www.fool.com Web sites. When you’re ready to open a brokerage account, visit www.broker .fool.com for more info.
My dumbest investment
Shortly after my children were born, they were given stock in AT&T by their grandparents. (Granddad had worked for the phone company all his life.) The shares were received as actual stock certificates, not in a brokerage account. With the company’s many spin-offs and splits, we received stock in the new companies. One of the few I added money to was Lucent. To complicate matters, we moved several times, and I lost track of what we owned and forgot to notify the companies of our new addresses. Subsequent dividend checks were returned to sender. We didn’t consider selling these stocks because they were “family,” even when Lucent was dropping like a rock. My main lessons: Don’t be emotional about gifts of stock. Don’t hold on to anything without making a diligent effort to understand the company. Keep shares in a brokerage account. – Deborah Gray, El Cajon, Calif.
The Fool Responds: We can’t add much more to those great lessons. At least the stock you began with was AT&T and not PanAm or Woolworth.