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Mind the GAAP
THE MOTLEY FOOL
Ask the Fool
Published: October 28, 2021
Q: What's "GAAP"? -- A.M., Santa Maria, California
A: Investors are likely to see references to GAAP -- an acronym for Generally Accepted Accounting Principles -- when reviewing companies' financial statements, such as balance sheets and income statements, or when reading companies' earnings reports.
As you might imagine, there would be a terrible apples-and-oranges problem if every company could report its earnings and its financial health using any rules it wanted. That's why the Securities & Exchange Commission (SEC) requires publicly traded U.S. companies to adhere to GAAP rules and standards. For example, GAAP requires companies to accurately recognize and account for all of their assets, liabilities, revenues and expenses. When companies follow GAAP, investors and others can more easily compare results among them.
Private companies, including most small businesses, typically don't have to follow GAAP. And many publicly traded companies, both big and small, report results on both a GAAP and non-GAAP basis.
Q: If a company acquires another company, does the acquired company's stock always go up? -- T.C., Horace, North Dakota
A: It depends on estimates of the acquiree's value and on the acquisition price. If a company's total market value, for example, is around $20 billion, and it's bought for $26 billion, its shares may pop up on the news.
Acquirers will often pay a premium if the acquiree is seen as desirable, perhaps due to strong brands or valuable technology. Paying a premium price can also dissuade other companies from competing to buy the acquiree.
Meanwhile, a struggling company may be bought for relatively little. If investors think that an acquirer paid too much or that the deal is a poor one, its stock price may fall.
Fool's School
Early Mortgage Payments?
It's tempting to want to pay off your mortgage early, and there are reasonable reasons to do so. For example, if retirement is looming, it can be good to enter it without mortgage payments hanging over your head. But there are also good reasons to not pay off that home loan early.
For starters, you'd have less access to ready cash, should you need it. If you pay off your mortgage by wiping out some of your bank accounts and selling stocks in your brokerage account, yes, you'll be free of the loan. But you'll also have transferred a lot of asset value into your home -- which is not that easy to retrieve money from, if and when you need it. Should you need to buy a new car or pay college tuition, you can't just sell a fraction of your house. You'd have to either sell the house or take out a second mortgage or home equity loan, and that can take months.
Next, putting much of your available cash into your home means you can't use the money for other long-term goals, such as investing in retirement accounts. Think of it this way: If your mortgage interest is 4%, every dollar you use to pay off that loan is like earning a guaranteed 4% return because you won't have to pay 4% on it. Meanwhile, the stock market has averaged annual returns of close to 10% over long periods. Even if your stock investments were to appreciate by 6% or 8% per year, on average, you'd be likely to come out ahead. Of course, much depends on your mortgage interest rate and investment expectations.
Finally, you may lose a valuable tax break. People who itemize deductions on their tax returns are allowed to deduct the mortgage interest they pay -- and that can be a hefty sum. Once your mortgage is paid off, there will be no more interest payments to deduct, which can leave you with bigger tax bills.
My Dumbest Investment
Dot-Com Bomb
My dumbest investment was in shares of eToys, way back when. I figured: What could be better for parents than being able to find toys online and have them shipped to your door without your kids hounding you for things they see in toy stores? Brilliant. Unfortunately, eToys was one of the first dot-com companies to absolutely tank, pretty much to zero. Good thing I didn't have much money invested at the time! -- O.S.B., online
The Fool responds: The company had quite a short life: eToys was founded in 1997 and went public in 1999; it filed for bankruptcy protection in 2001, shortly after losing some 99% of its value and laying off 70% of its workforce.
What went wrong? Well, the company spent a lot on marketing and products to fill warehouses -- and on acquisitions; for example, it bought BabyCenter with shares worth around $150 million at the time. (Johnson & Johnson later bought BabyCenter for $10 million.)
Fortunately, you didn't lose too much. It's great to find companies with ideas and plans that seem like they can't lose -- but sometimes they do. Investors can even lose a lot when investing in great companies by overpaying for the shares. (Many good companies had wildly overvalued stocks before the internet bubble burst in 2000.) It's often best to wait for not-yet-profitable companies to start posting profits, or to at least post shrinking losses.
Foolish Trivia
Name That Company
I got my start in 1888 as the Pittsburgh Reduction Company, founded by a guy who patented a low-cost aluminum production process. My light and strong alloys were used in manufacturing automobiles by 1901 -- and part of the Wright Brothers' 1903 "Flyer" plane. I introduced aluminum foil in 1910 and, a century later, a reclosable aluminum bottle in 2014. I merged with Reynolds Metals in 2000. Today, with a recent market value topping $10 billion, I'm a global leader in the production of bauxite, alumina and aluminum. I also recycle more than 1.3 billion pounds of aluminum annually. Who am I?
Last Week's Trivia Answer
I was founded back in 1986, but I'm now a combination of several fitness brands, including Bowflex, Schwinn and JRNY. (Schwinn dated back to the late 1890s, making successful racing bicycles in its early days and introducing indoor exercise bikes in 1965.) Based in Vancouver, Washington, I rake in more than $700 million annually, and am aiming for $1 billion by fiscal year 2026. I recently sported a market value near $270 million. I offer products including elliptical machines, home gyms, indoor bikes, treadmills and adjustable all-in-one free-weight systems, as well as the JRNY fitness app. Who am I? (Answer: Nautilus)
The Motley Fool Take
Energetic Dividends
France-based integrated oil giant TotalEnergies SE (NYSE: TTE) is a good fit for dividend-seeking investors interested in the energy sector, and in the transition from carbon fuels to cleaner energy sources.
TotalEnergies' operations span from upstream (exploration and drilling) to downstream (refining and chemicals). It's reworking its portfolio to focus only on its best oil investments, while expanding its footprint in cleaner-burning natural gas and boosting its operations in renewables and electricity. Its ambition is "to become the responsible energy company," and it plans to spend roughly half its annual capital spending budget of $13 billion to $15 billion on growth businesses over the next four years, with much of that earmarked for natural gas and renewable power.
Meanwhile, TotalEnergies is a robust dividend payer, with its payout recently yielding 6.1%. It recently updated its dividend outlook, noting that oil prices averaging above $50 per barrel could lead to dividend increases. (Oil was recently trading in the $80-per-barrel range.) TotalEnergies is also buying back $1.5 billion worth of stock as a way to return value to shareholders.
To be sure, TotalEnergies has its flaws; for instance, it has more debt than many of its U.S.-based peers. However, its dividend commitment and its efforts to change its portfolio while continuing to grow its business make it an attractive energy investment for long-term investors.
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