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'Black Swan' Stocks Could Lose 50% or More Due to Accounting Practices


These are companies that investors should run away from screaming as loudly as the victims in horror movies.

A day before Hewlett-Packard (HPQ) announced an astonishing $8.8 billion writedown associated with its acquisition of Autonomy, the governance analysts at GMI Ratings released their first "Black Swan Risk List." Right there on the roster of companies that GMI believed to offer a disproportionate risk of something going very wrong in the near future – a so-called Black Swan event – was Hewlett-Packard's name.

GMI has since produced a second list of 40 companies with a market capitalization north of $5 billion that it believes have extraordinarily aggressive accounting practices. "Inclusion in this list," said GMI CEO James A. Kaplan, "signifies an elevated risk of adverse events that can materially affect share prices." Translated, that means these are companies that investors should run away from screaming as loudly as the victims in horror movies.

Some of the companies on the second list of 40 potential Black Swans – all of which GMI believes may see a stock price decline of 50% or more in the next six months because of their accounting policies and the problems that these have created – have already been in the headlines for all the wrong reasons.

Chesapeake Energy (NYSE:CHK), for instance, has been trying to resolve its ongoing business and governance woes in a very public fashion for much of the year. Western Union (NYSE:WU) is struggling to come to grips with changes in the payments business that have brought about new kinds of competition and shrinking profit margins.

Other names, however, may well raise your eyebrows. Mastercard (NYSE:MA) makes the list, as does Tiffany & Co. (NYSE:TIF). The former has been one of the outperformers in 2012, rising 32% so far this year. While Tiffany's stock price has flagged, market chatter has linked that more with questions about high-end retailers rather than company-specific accounting woes. Among financial stocks, Bank of New York Mellon (NYSE:BK) makes the list, but the megabanks that investors love to loathe, such as Citigroup (NYSE:C) or Bank of America-Merrill Lynch (NYSE:BAC). Indeed, the banking universe is under-represented on the GMI list relative to its weighting among large-cap stocks.

GMI may have gone out on a limb, but its success in giving investors a very early warning (dating back to 2009) about problems that could weigh on Hewlett-Packard's stock price mean that this is the moment it can trumpet the value of forensic accounting in general and the need to constantly question the validity of reported financial statements.

In the wake of the Bernie Madoff Ponzi scheme, the misleading accounting of companies like Enron, WorldCom and Tyco, one might be forgiven for thinking that this is a lesson investors already have learned. Evidently not, or Hewlett-Packard's writedown amid allegations that Autonomy hid or failed to disclose accounting improprieties wouldn't have come as such a bolt from the blue. After all, Hewlett-Packard had ranked high on GMI's risk model for more than three years, long before the vast majority of investors suggested there might be anything amiss.
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