Figurers Figuring and Getting Fact

“Figures don’t lie, but liars figure.” —Mark Twain

“The whole American economy is built on a series of lies,” cynical types say when the conversation switches to matters they know nothing about. They may have heard something from someone they trust, and some of what they heard may have had some half-truths in it and some figures that provided enough anecdotal evidence to make a claim. More often than not, these claims are made to appeal the confirmation bias of the audience, and they have little basis in fact.

The reason such claims appeal to to the cynics is that they’ve never had skin in the game, and they’ve always been a little bitter about that. Rather than come right out and tell you that, they suggest that there is a very specific reason why they won’t play the sucker game that you do, and it all boils down to the fact “The fact I tell you!” that the whole game is rigged.

bailoutAs usual with such hysterical rants, there is a grain of truth to what they say, for if they didn’t have some attachment to the truth, they might be too embarrassed to launch in the manner they do. The truth is that the assessments made about the American economy are built on a series of figures, and those figures are not lies, but nestled within that truth are some partial truths, cloudy figures, and accounting gimmicks that suggest a relative truth to keep measurements, such as the all-important consumer confidence index, high.

Economists, with no skin in the game, will tell you that a true assessment of the economy can no longer be found in some of the official facts and figures that are considered standard measurements of an economy. Some figures, like the Dow Jones Industrial rate, and the unemployment rate, can be spruced, fluffed, and spanked into a satisfactory report that leads information gatherers to report that all is well. If that is the case, are the reports on the American economy nothing more than a series of little, white lies from the various sectors of our economy that figurers figure to keep us quiet and happy?

Some apolitical economists that pour through data to make their determinations on the health of the economy, now look to one indicator to determine the state of the economy: the real wage index.

The real wage index, put simply, measures the average consumer’s wage against their purchasing power and the resultant effects of inflation. The more complicated algorithm used to determine real wages can be found here and here.

Political economists, with skin in the game, will provide a number of indicators that suggest that economy is booming. They will often do so by keying in on two indicators, the unemployment rate and the Dow Jones Industrial Average. These indicators have been regarded as standard indicators for so long that those of us that know little-to-nothing about economics have accepted these reports as a time-honored method of revealing the health of the economy. The dirty little secret is that these figures, and others, are malleable and subject to interpretation.

When political reporters and political economists list the unemployment rate, they provide the American public the U3 rate. The U3 rate is the rate you know, as it has been declared the official unemployment rate for longer than most of us have been alive. As the Macrotrends website displays, in charts, actual unemployment figures are a bit more complicated than that, and even though the two other employment rates are not as widely reported, and not considered as official, they are just as illustrative of the state of the economy. One of the reasons that the other two rates haven’t been widely reported over the years might stem from the fact that they tend to fall in line with one another, and the chasm between the two is often not very wide. Over the last nine years, however, this gap has widened to a degree that the other two rates should now be reported in conjunction with the U3 rate. One of the other rates is the U5 rate that includes “discouraged workers and all other marginally attached workers” in its calculation. The U6 rate “adds on those workers who are part-time purely for economic reasons. The Illinois Policy website also states that the U6 rate includes “unemployed people who haven’t looked for work in the past four months but have sought employment in the past year.” The current U3 rate for the nation is listed at 5.1%, the U5 rate is 6.2%, and the U6 rate is currently listed as 9.8% for the month of October 2015, according to Macrotrends.

In a similar manner, the scaled average of the Dow Jones Index can provide a sense of false security that keeps the consumer confidence index high and leads to greater consumer spending, more investing, and it can also lead to consumers voting for the party in power, a party that the consumer believes created the climate for the booming economy.

As of this date, November 19, 2015, the Dow Jones is currently listed at around 17,500. It’s been as high as 18,200, and it’s been as low as 6,600 in the last fifteen years. It’s not recession proof, in other words, and it can still be used as an indicator of an overall economy. There are, however, so many legal accounting gimmicks, reporting practices, and maneuvers that individual companies can use to inflate their numbers, to attract future investors, that many apolitical macro-economists avoid using the Dow Jones as a benchmark in their final determinations on the state of the economy.

The Dow Jones is nothing more than a stock market index of thirty large stocks over varying industries that those in charge of the Dow Jones index declare to be representative of market conditions. As such, the Dow Jones is simply a scaled average of investor activity. Or, as Investopedia defines an index “an assessment of those people that invest and their general attitude toward companies of all different sizes and from varying industries.”

The quintessential method some learned investors, and some novices, use to purchase shares from a company is to study the profit figures that a company is required to report on a quarterly basis, otherwise known as the quarterly earnings report. Even most learned investors don’t have the knowledge, or the time, to examine the fine print of a quarterly report, so they look for the headline, the Earnings Per Share (EPS) figure, and they compare it to where the various stock analysts assumed (guessed!) those figures should be.

A company’s EPS number is derived from taking a company’s profits, or earnings, or operating cash flow, and dividing it by the number of shares available to the public.

buybacks_diagramSome would say that although EPS is listed as the standard form of measurement by the investment community, it has been manipulated so often that Investopedia states that the practice of manipulating the EPS number might be the world’s second oldest profession. As a result of this, they suggest focusing on the company’s operating cash flow portion of the EPS equation. One of the reasons for this is that some companies have manipulated the other side of the EPS equation by “buying back” a number of available shares on the open market to lessen the total number of shares available in the EPS equation, thus driving the EPS number up.

The reason that this is important, even to those that have no plans to invest in the market, and care little about it, except what it may detail for the American economy, is that as more investors clamor for a stock on the false premise of a high EPS number, the higher the Dow Jones goes, and the better the world thinks the U.S. economy is.  One could say that it is the equivalent of a completely legal, accounting shell game.

If a company has the profit necessary to purchase more shares in their company, shouldn’t that be a statement of confidence that they have in their company? Yes, but the counter-point from a novice investor might be why doesn’t the company put more of that profit into their research and development, better employees, etc.? Such an investment in the company, it would seem to the average investor, would be a more long-term investment in the company, and a buyback would satisfy investor concerns for one quarter.  The answer is that both investments are a statement of confidence, but there is a specific reason why a company would opt to buyback more shares rather than invest in other ways.

The difference, according to a Wall Street Journal quote from a managing director at investment firm Mellon Capital Management Corp., named Warren Chiang, is that:

“Executives are compensated [based] on EPS.  EPS growth is the primary reason they do buybacks.”

Gregory Milano, chief executive of business consulting firm Fortuna Advisors LLC, said that companies that avoid buybacks usually outperform those that embrace them over the long term.

“It’s kind of like a kid in school. A lot of kids are motivated by getting the best grades they can; other kids are focused on learning as much as they can,” he said. “While the child with better marks might have a leg up entering the workforce, the kid who understands (the subject matter) better has a better career.”

A buyback may be a useful tool for a company experiencing a temporary bad quarter to pursue, as it creates the illusion that the profit (or earnings) for that quarter is higher versus the number of shares available in the EPS formula, but the question those of us that are just now learning the specifics of this tool are wondering is how much of this type of stock price manipulation is already baked into the current price per share, can this practice continue ad infinitum, as long as there are some shares available, and some profit available with which to purchase it?  How much of the price per share currently listed is based on artificial manipulations, and how will this practice affect the price going forward, if at all?

“A segment of investors, both retail and institutional, believe that buybacks are financial engineering, where the purpose is largely to create wealth in the form of stock-based compensation for management,” says a Ben Silverman, vice president of research at InsiderScore, an institutional research firm that tracks buybacks and legal insider trading.

Ben Silverman is also quoted in the Wall Street Journal article as saying:

“We think in some cases that buybacks are a tool used by managers and boards that don’t know what else to do with the cash.  They’re either not creative or not growth-oriented. There’s always something to invest in, no matter what kind of company you are.”

As more and more large companies begin to pursue such smoke and mirror practices –some articles have it that one in four companies are now engaging in buybacks as a regular practice at this point– it increases the overall profit of a sector, and the market, until consumer confidence begins to increase, and the illusion that an economy is vibrant becomes such an agreed upon assessment that board members, CEOs, and state and federal politicians get re-elected, but the question that some of us now wonder is, is it possible that our cynical friends, and their trusted sources, are closer to the truth than they even know, and will all this legal deception one day lead to a sort of buyback crash?

It’s possible that this may never occur, as these companies are using profits in these buyback purchases, just not as much profit as those that look at EPS numbers for their answers are led to believe. It’s also possible that some of the highest flyers in the market have, as Ben Silverman suggests, managers and boards that don’t know what to do with all their profit.

My cynical friends may have fallen backwards into a truth, but that doesn’t suggest that the whole American economy is built on a lie.  The American economy is built on facts, and facts don’t lie, but as a prominent statistician, named Carroll D. Wright, once said of the figures that form those facts:

“The old saying is that “figures will not lie,” but a new saying is “liars will figure.” It is our duty, as practical statisticians, to prevent the liar from figuring; in other words, to prevent him from perverting the truth, in the interest of some theory he wishes to establish.”

The current consumer confident index would inform Mr. Wright, and mr. cynical with his trusted sources, that their fears have proven unfounded. The figuring figurers have found a way to have their cake and eat it too. Had Mr. Wright heard the line from Seinfeld “A lie in not a lie, as long as you believe it” he may have re-figured his thoughts to suggest that record growth in the stock market and low unemployment rates are possible under any theory, as long as the perversions of truth are collective. And even if the particulars of the economic theory “He” wishes to establish results in some perversions of truth that prevent cynical types from ever getting ahead, we can put economic mechanisms in place, such as prolonged low interest rates, Quantitative Easing measures, corporate buybacks, and something called Dodd-Frank to foster a sense of confidence that economic collapse is no longer possible in the world today.


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