"I'll meet you back here in 18 years when my wife is in charge."

“I’ll meet you back here in 18 years when my wife is in charge.”

Like our buddy Bill’s “problem” back in 1998, most accounting problems aren’t so bad. People huff and puff for a while, stuff looks like it’s about to get real, and then things go back to being normal again.

We can look at accounting scandals in one of two ways. They’re either intentional, or accidental. The intentional case involves an outright fraud. The accounting department knows the books aren’t right, but either the CEO puts pressure on the department to hit a certain number, or the CFO does it in order to hit bonuses. The unintentional case involves doing things a bit aggressively, and then finding out about it afterwards, either by a new CFO or during an audit.

The unintentional case is exactly what happened with Penn West. The company got a little too aggressive classifying operational costs as capital costs, which led to it citing a funds from operations number that was a little higher than it really was. That’s bad, obviously, and the company has since restated the affected numbers.

But how bad is it? Funds from operations isn’t even a GAAP value. There are certain liberties an accounting department can take with it. It’s all fine and good until the new CFO comes in and wants to do things “right”. This lasts for a few years until the new CFO wants to hit a certain number, and the cycle repeats itself.

We do this in all sorts of ways in our own lives. How often do you round up with pointing out something like your salary? Or round down when explaining to your spouse how much those new shoes cost? This is human nature, and it will continue forever. That’s one of the reasons why you should always insist on a margin of safety when buying a stock.

Recently, a company called American Realty Capital Properties (NASDAQ:ARCP) has been in the news, thanks to the CFO and one other guy intentionally inflating the REIT’s funds from operations number. The company immediately whacked the CFO and had a conference call to ease concerns, but it didn’t matter. The stock is down 30% since the scandal hit.

It’s easy to draw the difference between ARCP and Penn West. Or is it? Sure, one group did it on purpose, but there’s a fine line between helping your FFO number come at the best possible number and starting out with a number in mind and then doing everything you can to get to get the results to match it.

Depending on your perspective, an accounting scandal can either be a good buying opportunity or a good reason to sell immediately and never visit it again. Most investors tend to go for option B, which usually explains why a stock will sell off 30-50% even at the whiff of something improper happening with the books. Never mind that improper stuff happens all the time and people don’t get caught. We need to focus on the here and the now, dammit.

I took a look at ARCP last week when I first heard about this and ultimately passed. The company has grown like crazy since its IPO a few years ago, and word is it was bidding aggressively when assets come up for sale. That kind of growth at all costs mentality doesn’t appeal to me, so I didn’t get as far as cracking open an annual report.

But the whole situation got me thinking a couple of days later when I read about Proctor and Gamble’s problem in Argentina. Essentially, Argentinian authorities are accusing the company of over billing $138 million in imports in order to get money out of the country. Considering Argentina’s mess of an economy, I’m not entirely surprised.

This news came out on November 3rd. How did P&G’s shares do that day?

I’ll spare the suspense. They went up. Collectively, the market yawned at the allegations. Which got me thinking. What exactly is so special about this scandal that caused investors to not care?

There are a few possible explanations. It’s crazy Argentina and therefore doesn’t matter is certainly one. It isn’t really an accounting scandal, it’s more like a lying to a government scandal. And it just affects a small amount of the company’s business rather than the whole thing. But still, a scandal is a scandal. Why will investors dump a company like Penn West for a minor thing, yet not care in the slightest when P&G does something similar?

Here’s the point. Most accounting “scandals” aren’t a big deal. The company gets in trouble, corrects things, and ends up paying a token fine to regulators. It’s not a big deal. If you look at buying stocks that, after accounting scandals, are priced attractively, I think you’ll do well. A study done in 2002 isn’t exactly compelling evidence, but it shows that an investor would have beaten the market by nearly 20% if they would have bought a month after each scandal and sold a year later. It only covers 9 stocks, which is part of the problem, but I think this would work out well. Somebody should start an index of this. Hell, maybe it’ll be me.

Anyway, don’t be scared of accounting scandals. Be wary, and insist on a margin of safety, sure, but don’t be scared to buy.

Tell everyone, yo!