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Investors being misled by earnings, wisdom from Coxe and Rosenberg, and why 20 stocks are all you need

Some companies are playing the numbers game with their financial statements.


What would investors own if they were only allowed to make 20 investments in their lifetime? Warren Buffett believes their portfolio returns would improve by following this strategy because, "Under those rules, you'd really think carefully about what you did, and you'd be forced to load up on what you'd really thought about. So you'd do so much better."

John Hempton, a globally-prominent Australian hedge fund manager revisited this Buffett concept in a recent blog post that, in my opinion, is a must-read for Canadian investors. Mr. Hempton writes that for professional investors, it's impossible to emulate Mr. Buffett's patience and uber-disciplined stock selection process.

"I did not find a new stock that met [the 20 stock limit] test this year. Or last year. Or the year before. Or the year before that. I found one in 2012. … But I am incapable of sitting idle since 2012 and so I do stuff. Inferior stuff. Stuff that may produce inferior results."

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This is a remarkably honest confession from a portfolio manager. I suspect all investors recognize the sentiment, the urge to act in the markets even while suspecting there's nothing intelligent to do.

So many have tried and failed that I suspect Mr. Hempton is right and only Mr. Buffett can do what he does. Thinking like Warren Buffett, however, has tremendous benefits and only acting with conviction, only when perfect opportunities arise after extensive study, is a good place to start.

-- Scott Barlow

The numbers game

Did you know that in 2004, just a handful of companies in the S&P/TSX 60 used non-GAAP measures somewhere in their annual reports? Today, 59 do. The only exception: Imperial Oil Ltd. David Milstead, with the help of a detailed report by Veritas Investment Research Corp., delves into what this all means and how it affects the stock market and investors. Here's a list of the stories from our big weekend package:

How investors are being deceived by non-standard accounting moves
In an attempt to burnish their image with investors and drive stock prices higher, companies are offering up a host of gerrymandered measures to make their costs appear lower, and their profitability higher. The use of these customized earnings measures -- often called "adjusted earnings" -- that do not adhere to generally accepted accounting principles is growing in Canada, posing a quandary for both regulators and the investors they're charged to protect, writes David Milstead.

Poof! How BlackBerry instantly turned a $670-million loss into break-even performance
How does a net loss of $670-million (U.S.) – or $1.28 a share – turn into a break-even performance? By excluding 10 different expenses across 13 areas of the income statement when calculating "non-GAAP net income," the number BlackBerry Ltd. prefers investors look at, writes David Milstead.

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How five companies use non-standard financial measures to make earnings look better
David Milstead looks at five companies -- BCE Inc., Kinross Gold, Agnico-Eagle Mines, Pembina Pipeline, and Magna International -- to examine how they adjusted their earnings and asked companies to explain their decisions to exclude certain expenses from their non-GAAP balance sheet.

Canadian securities regulators on high alert over misleading earnings statements
Canadian regulators are warning companies not to mislead investors with non-standard financial measures in their press releases and other securities filings, and have asked some companies to change their practices or refile statements, writes Janet McFarland.

Investors need to stop blindly believing in the financial metrics of TSX stocks
According to Bloomberg, the S&P/TSX index is trading at 22.7 times trailing earnings. But what if you knew that the majority of the figures used to calculate that metric were each company's own creation, were not audited, and might not be comparable? Now what if you knew that the same index was trading at 48.9 times earnings using the figures that were produced according to the appropriate accounting rules and independently audited, asks Anthony Scilipoti, chief executive officer and founding partner of Toronto-based Veritas Investment Research Corp., which provided the report on the TSX and non-GAAP earnings our special story package was based upon.

Stocks to ponder

Brookfield Renewable Partners L.P. This renewable power stock appears on the TSX positive breakouts list. This defensive security offers investors an attractive 5.6 per cent yield, and it may retain its value amidst potential market volatility relative to other investments, writes Jennifer Dowty. It's trading below its historical valuation levels and there are eight analysts with "buy" recommendations, five with "hold" and two with "sell" recommendations.

TMX Group. This company provides services such as exchange listings, trading, clearing and settlements for its marketplaces, notably the Toronto Stock Exchange and the TSX Venture Exchange.  It is the top-performing financial stock this year on the TSX, but you might want to wait for a pullback before buying in, writes Jennifer Dowty.

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Spectral Medical Inc. This is a stock that can be extremely volatile and as such is only suitable for growth investors with a high-risk tolerance within a diversified portfolio, writes Jennifer Dowty. It briefly appeared on the positive breakouts list on Monday. The stock is covered by three analysts – all of whom have 'speculative' buy recommendations on the stock given its risk profile. The stock has a potential near-term catalyst that may continue to fuel its positive price momentum as it is seeking  U.S. Food and Drug Administration approval for its product, Toraymyxin (PMX), aimed at treating individuals suffering from severe sepsis and septic shock.  PMX was approved for use in Europe in 2001 and in Japan in 1994. The average one-year target price is $2.75, which implies 47 per cent upside potential over the next 12 months.

The Rundown

How a retired university professor outperforms the market
This retiree looks for blue-chip stocks and follows a "Dogs of the Dow" philosophy that's focused on the TSX, "Beating the TSX." He likes buying up solid stocks that are going through a rough patch.

Don Coxe: Here's what I'd be buying if I were you
There is one over-arching reason why you should not be rushing from stocks into cash: too many experts who have been too bullish for too long have finally awakened to the problems of the American, European, Chinese, Japanese and Canadian economies at a time stock markets have been acting as if worry isn't warranted, writes Don Coxe. He broadly outlines some investments he's liking right now.

Series D mutual funds worth a closer look
From the mutual fund world comes an overlooked friend to the DIY dividend investor, writes Rob Carrick. There's only a small crop of Series D Canadian dividend mutual funds, but they're well worth a look for the investor who wants a dividend-focused portfolio conveniently packaged into fund form.

Shift to index investing only in 'early innings'
The humble index fund has proved to be a truly transformational financial creation, bringing about a permanent shift in consensus investing wisdom. When Vanguard introduced the first index mutual fund 40 years ago, it was denounced by Wall Street stock pickers as a tool to embrace mediocrity, and even un-American. Now, index-tracking funds account for more than 30 per cent of the market. And Vanguard, as the industry's champion of low-cost, passive investing, is the world's largest fund company with $3.6-trillion (U.S.) in assets, writes Tim Shufelt.  Joe Brennan, the head of Vanguard's global equity index group, spoke to The Globe about index investing's past and future.

Buffett's key to investing: Four stocks that show a durable competitive advantage
Some investors seem to have a formula for finding bargains regardless of the current market and economic climate. The billionaire Warren Buffett, known as the Oracle of Omaha, looks for companies that have a durable competitive advantage to others in their industry, another way of saying he looks for a cash cow, or a company that performs year in and year out regardless of the state of the economy or what's going on in the world, writes John Reese. He's used his Buffett-inspired stock picking model to find four solid performers worth a look, including Apple Inc., Nike Inc., Alimentation Couche-Tard Inc., and Ritchie Bros. Auctioneers Inc.

Here's where to find value in an overall pricey stock market
With the S&P 500 priced for more than just mere perfection – a forward price-to-earnings (P/E) multiple of 18.5, fully two standard deviations above the long-run norm of 15 – where do we still find some value?  The best valuations reside in consumer discretionary, telecom, financials and materials. A real mix, writes David Rosenberg. In Canada, the most attractive valuations are in financials and consumer discretionary.

Five TSX stocks with a rising profit outlook despite slow-growth economy
The longer-term economic backdrop for markets is both problematic and deteriorating and this will make stocks with legitimate, sustainable profit growth even more difficult to uncover, writes Scott Barlow. Screening the S&P/TSX composite, there are five stocks that, for now, are defying the trend of slowing economic growth where analysts are raising profit forecasts: Fortis Inc., Bank of Nova Scotia, Descartes Systems Group Inc., Interfor Corp., and TMX Group.

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What's up in the days ahead

Gordon Pape in Tuesday's Globe Investor will outline some investment ideas in a negative interest rate world. Meanwhile, John Heinzl will reveal five dividend stocks that have a growth catalyst.

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Compiled by Gillian Livingston

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