Difficulties an Analyst has in Equating Cross-Border Companies
The era of modern globalization, along with the technological advances engendered by computer software, multi-national companies and the Internet is causing and has caused major changes in the equities market.
The increased familiarity of ever-larger pools of investors in companies outside of their own borders is not longer the exclusive province of institutional investors or the individual of high net worth. And while still basically in its infancy, global investment opportunities are becoming a playing ground for the average investor as analyst with this type experience reaches into their demographic domain. The information explosion caused by the Internet as well as the mounting needs of companies to broaden their investor base, are a few of the long list of contributing factors to this phenomenon.
The preceding generalization has thus become an operative concern of an increasing pool of analysts in guiding recommendations made to clients as well as their own firms. The broadening of the analyst field, in terms of their numbers also brings with it the need for understanding of ‘cross-border’ equities and the means to equate data to result in the formulation of recommendations. The common field of referencing, with regard to key corporate metrics (Thieke, 1995) is thus compounded as a result of the subtle as well as key variables that are affected by differing laws, methodologies, terminology and currencies. The foregoing list masks the extent of the areas within each field. An examination of the preceding, is the focus of this document, as well as the potential remedial recommendations that analysts could employ to heighten their success in examining such ‘cross-border’ equities.
Introduction
With the above as the base of reference, the task of the analyst in examining the various metrics pertaining to a given, or any, ‘cross-border’ equity represents a daunting series of equations as well as understanding with regard to the actions and plans of the company(s) in question. The varied considerations that accompany the foregoing are all factors in the analyst reaching a determination. The circumstance and conditions contributing to this problem, in many instances, include the companies themselves. Stanutz (2005) in broaching this area asked what metrics are considered most effective for evaluating companies.
Her question provides the basis for focusing on the key as well as critical components that an analyst, by and large, should consider in their examination. From this identification the basis for foundational areas comprising this examination can be derived. Stanutz (2005) takes this same approach as she asked what attributes male a company a superior company? From this direction it is apparent that the process entailing an examination of a ‘cross-border’ company does not differ, fundamentally, from the process utilized in the analysis of any other. Simply stated, it entails an understanding of what to look for and how to interpret that data.
As the yardstick by which all business enterprises are measured are revenue, growth (which takes in a broad plethora of sub topics), and profits, the areas comprising this analysis lie within the firms reports, which is a function of accounting. As the subject companies have been identified as Toyota and Ford, rather than delve into the nuances of their individual balance sheets, statement of earning and other reports, the focus will be on the aspects that affect their proper interpretation.
Uncovering the Difficulties
As Toyota and Ford are both within the same industry classification, the similarities with respect to their operations from an product, market and accounting standpoint are obvious. Thus, the identification of the salient analysis points will provide the basis for examining the difficulties encountered in equating these companies as the ‘cross-border’ comparative examples. Thieke (1995) and the work of the Securities Settlement Committee identified the following as the major areas in examining ‘cross-border’ risk:
Liquidity Risk
This identifies the ability of an institution to meet its obligations
Credit Risk
This indicates the balance in the company with respect to its debt versus assets and earning capability to handle said debt.
Time Gap Risk
This area broached the factor of time with respect to currency fluctuations.
Systematic Risk
The aspect of defaults within a particular country triggering other defaults and the status of that country’s economic vitality.
Legal Risk
This represents the applicable laws and their application with respect to the subject companies within their country of domicile.
Sovereignty Risk
This is the ability of a particular c=government to be able to step into the business market and either legislate changes, control outcomes or seize assets.
Of the preceding, one, two, and three are accounting related. Considering that in the case of both Japan and the United States, the legal and sovereignty aspects as stabile, the remaining four will thus serve as the basis for examination. The outstanding component governing the following is the differences in accounting systems represented by the United States Generally Accepted Accounting Principles (GAAP, and the International Financial Reporting Standards (IFRS) that governs Japan (, 2004). Within these two systems, the following reporting areas represent differing applications of accounting methodologies whereby the subtleties can be lost, thus leading to potential misunderstandings in what and how things are being reported, and thus, how they stand.
Classification of liabilities,
Asset exchanges,
Financial Instruments,
Discontinued operations,
Inventories,
Accounting policies,
Assets held for disposal,
Income taxes,
Interim Financial Reports
Accounting is a formation as well as information control measure whereby executives are able to understand the various aspects of their business by its gathering of information which is then translated into the result attaining, using currency (Simons, 1987). As such, the first four elements as identified by Thieke (1995), hones in on the important considerations thus affected by the foregoing
Liquidity Risk
This area, along with Item number 2 (Credit Risk), are best served by utilizing EBITA (Wikipedia, 2005), which is Earnings Before Interest, Taxes and Amortization, as the broad basis for comparison was identified by Stanutz (2005)
Credit Risk
This is included in the above.
Time Gap Risk
This entails the analyst understanding the financial position of the company in its reports for a given period or periods of time. Herein, the problem is compounded by the analyst’s familiarity with his own currency, that he must translate into the subject currency and arrive at a common basis for understanding. In the case of Toyota their financial statements are stated in both British Pounds and Yen.
Systematic Risk
The economic conditions prevalent within a particular country, in this case the United States and Japan, also affects the accounting items as ell as relative performance of a company as a result of the currency fluctuations at that given point in time. The preceding indicates that in reviewing and analyzing these companies, the currency fluctuation rates affect EBITA and all of the other factors within the differing accounting standards.
Conclusions and Recommendations
The foregoing analysis has outlined the some of the more important considerations that an analyst must consider as well as equate in reviewing and recommending equities of a cross-border nature. The measures that can be employed to ease the task of making these calculations and translations is via software designed to convert differences in the analyst’s accounting and monetary standard of either choice or application thereby providing him with the basis for being able to review the cross-border company with a high degree of comfort.
The preceding sweeping recommendation, in terms of software, is not as costly or difficult as it seems. The utilization of Excel macros can accomplish the preceding and be easily done by an individual analyst himself, in lieu of a sweeping software program along with the expense. The critical aspect of the foregoing is naturally the entrance of the original data in order for the software and or Excel programming to take effect, however, considering the lengthy process of performing this operation on a case by case or financial period basis, the answer is obvious.
Tags: analyst, company, cross-border, currencies, government, revenue, risk
