Apr 21 2009
What Do They Mean: Corporate Earnings, Mark-to-Market Accounting, Uptick Rule
If you are new to this site or our radio show, below are some of the issues we’ve recently discussed:
Corporate Earnings: Profit you have left after all expenses including non-cash expenses, such as depreciation expense, have been deducted from your sales for a given period. Depreciation is a way to spread expenses over time. For example, if you buy a tractor for your business, the tractor will generate revenue for some time to come, so you only deduct a portion of its expense from this year’s revenue.
Earnings are not to be confused with actual cash flow as earning are an accounting measurement.
Mark-to-Market Accounting: This rule forces companies to mark their assets held on their balance sheet to current market prices. Sounds good in theory, however, what if there isn’t a market for your asset; what is the value? Zero?
This is what happened during the recent banking crisis. The market disappeared for packaged loans, so the only bids were very low – 20 to 75 cents on the dollar. Banks had to write down the value of their assets to this “market” price and take a charge against earnings.
This then forced the banks to raise more capital from either private sources or the taxpayer to increase capital ratios which explains why they stopped lending.
For example, let’s say you had a crisis come up and had to sell your house in a matter of hours and it sold for $50,000 (but it is worth $250,000). Mark-to-Market rules say that all the neighbors in your area now must reduce the book value of their homes to $50,000. Soon after, lenders show up at your doorstep telling you that you must make up the difference between your mortgage and the $50,000.
Thankfully this rule has been recently changed to prevent entities from being foreclosed despite having positive cash flow.
Uptick Rule: This was a rule put in after the Great Depression and repealed in July 2007. It basically said that you could not short a stock until the stock price went up. Remember, shorting a stock is borrowing shares of a stock from a broker and selling them in the market. You are hoping that the stock price decreases so you can buy it for a lower price to cover your short.
Your profit would be the difference between the price you sold the stock and the price you bought it back. Not a lot of investors short stock. Currently it is popular in the hedge fund market.
The argument for having an uptick rule is to prevent these sellers from continuously selling a stock thus driving the price down as the buyers disappear.
Is this a fair way to profit?
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