The inside story of the iconoclastic accountant who knows what the balance sheet hides.
Meet Joel Litman. He strikes an imposing even otherworldly presence… particularly if he’s recently flown in from his firm’s office in Manila. There, he commands a corps of number-crunchers, expertly trained in tracking down the Platonic ideal of pure valuation.
I’m accustomed to seeing finance gurus in Dockers and Patagonia vests. So I was surprised to hear that Joel always wears a three-piece suit. When we meet on a late-summer day in Baltimore, he’s paired said suit with wingtips, a pared-down paisley tie, and a Patek Philippe watch. The uniform rarely varies, he tells me, even when he’s on-site in the South Pacific.
It’s there, his home for half the year, where he oversees his staff of about 100 eagle-eyed accountants. Their work – correcting financial statements line by line to account for the 130 worst flaws and inaccuracies built into the standard rules by which accountants measure value – is as technically tedious as it sounds.
But what it all amounts to is more thrilling: a sort of hard-won secret knowledge that comes from not just knowing the rules of accounting… but knowing better.
Knowing, in other words, what’s wrong with the rules that dictate how companies are valued.
Because as Litman says, there’s plenty wrong. And knowing how it’s wrong is valuable.
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Litman and his team give their clients a perspective on the market that ordinary analysts either don’t know or conceal from all but a select group of investors. And the locus of this labor – as far as humanly possible from Wall Street – makes me feel like I’ve wandered into a Joseph Conrad novel.
For one thing, you’d be hard-pressed to get an American investment banker to build a painstakingly detailed database like the one his staff has developed over the last decade. Why not? “Because it’s boring!” Litman says. “It’s profitable, especially in the long term, but it’s not fun.”
What Litman has built since his firm, Valens Research, got its start in 2009 was made possible by hard work, yes. But also by the fact that the rules of accounting misrepresent actual values – more so than most investors realize.
Frequent weekday readers of the Financial Times may already know this. (I’m an infrequent weekend reader myself.) The standard system of rules that accountants use is often wrong. Litman’s ever-growing database corrects 130 of the most egregiously misleading errors baked into the rules system.
Some, like the rule that dictates how accountants evaluate research and development costs, are philosophically flawed: Are research and development costs an investment in future profit, or a loss? Often it’s the former, but not according to the accounting rules.
Others, like the rule that dictates how accountants report pension costs, were altered for short-term political expediency: “The pension accounting rule was developed with Congressional pressure in the 1990s to save the market from the appearance of loss in a high-stakes year for recession recovery,” Litman explains when I ask for the third or fourth time how on earth it all got so very, so convolutedly bad. “The rule was written to hide what would have looked like one bad year but could have been explained away. And it set in place a quarter-century of confusion.”
When you think about it, it almost makes sense: Accountants are a put-upon people. They do the math. They follow the rules. Even when they know the rules are wrong, they still follow the rules. I mean, they’re accountants.
But what if one day, an accountant took a look around at his rule-following colleagues, stood up from his desk piled with financial statements that the rules of his trade had left him no choice but to mangle – and said, “Enough is enough!”
Well, that’s basically what Litman did.
After most of a decade on Wall Street, he’d developed an even greater distaste for the way capital markets are reported. He published a case study in the Harvard Business Review, “Give My Regrets to Wall Street,” about a company weighing whether to go public or stay private. Its assessment of the downsides of leaping into the wild (and, Litman emphasizes, meaningless) world of public valuations was uncomfortably honest. Two years later, he left to start Valens Research.
He recruited Rob Spivey, an old protégé from his days on Wall Street, and opened a small office in Cambridge, Massachusetts, which is still their stateside home base. Even as a 19-year-old intern at Credit Suisse, Spivey stood out to Litman. His grasp of Wall Street’s biases was surprisingly sophisticated: Reporting real values to the public would never be a true priority at an investment bank whose primary loyalty is to its clients’ earnings. “When it comes to reporting values, the question for Wall Street is always going to be, ‘At what point do you become biased toward your clients?’” Spivey says, when I ask why he chose working with Litman over the Wall Street life favored by some of his business school classmates. When I ask whether he ever regrets it, he says life with Litman is more exciting: “You know you’ve got a little bit of an edge – and you know you’ve earned it.”
The calls they’re most proud of at Valens are contrarian analyses they were able to make with confidence because they knew what was wrong with the rules. And because they’d done the tedious math. Facebook, for instance, is a favorite…
When Facebook went public in 2012, the conventional outlook was “As reported, it looked like a terrible company,” Litman recalls. “But the reported values were wrong: They were pouring money into research and development, and paying employees with stock options” – both of which misleadingly undermined Facebook’s reported value at the time, because of the peculiarities of the accounting rules. And just as Valens predicted, Facebook rebounded.
Their call on Planet Fitness, too: “A ton of people said the stock was a short,” Litman grins. “They said, ‘I don’t know what these Valens guys are saying, this doesn’t make any sense.’”
And they were right, it didn’t make sense. Planet Fitness looked like an absurdly bad call because its strip-mall storefronts are leased. The accounting rule for valuing leases – a rule which, Litman explains, was so flagrantly misleading that its reform finally took effect this year – and the rule for deferred tax liability, which remains in place, grossly exaggerated their losses. Based on Litman’s read of the reported financials, he found, “Their expansion would actually cost a lot less than people thought. And the earnings that they generated ended up being a lot more than people thought.” The stock went up several hundred percent. And best of all for Valens and its clients and friends, everyone else had been looking the other way. It was an unloved company – its growth invisible absent an excruciatingly close read – and a radical idea.
Making the case for these calls sounds almost farcical the way Litman recounts it. He’s a kind of anti-Cassandra, saying, “It’s actually a great company: You’ve just got to look at Note 19 on page 78, then you’ve got to look at Note 25 on page 140 – and if you’re not looking at that detailed level, you’re not going to see the true numbers.”
The initial idea to right the wrongs baked into the accounting rules was planted at the very beginning of Litman’s career. As a fledgling accountant, he (in his own words) “lucked into a job” working for the authors of the official guide to the generally accepted accounting practices (“GAAP”).
In his early 20s, he developed an appreciation for the rules’ circumstantial flaws – and an unusually sophisticated sensitivity to the institutional biases that held the status quo in place. He might have hardened into a cynic, but a teacherly temperament and innate interest in the deeper reasons why the world works the way it does kept him curious about what he might do differently. He recalls running up to his bosses with questions about the rules – “Why is a statement of cash flows not a statement of cash flows? There are a bunch of non-cash items. Why?” – questions for which there are no reasonable answers.
He worked as a consultant and then led a research team at the investment bank Credit Suisse – but he couldn’t forget what he’d learned working with the authors of the rulebook: that while the accounting rules may produce the wrong numbers, the real numbers are out there if you only take the trouble to look for them.
What it all amounts to is more thrilling: a sort of hard-won secret knowledge that comes from not just knowing the rules of accounting… but knowing better.
Knowing wasn’t enough for Litman… He wanted to spread the word. Valens’ uniform accounting database is essentially a list of companies and their actual values, spanning the 10 years since Litman founded the firm. It’s set up to highlight the reported prices that are most meaningfully different from their actual prices – the “oranges,” per Litman’s favored idiom, among “apples.” Litman’s system labels the misleading reported values in orange. The real, corrected values it casts in blue.
Corporate clients can consult the whole color-coded, decade-deep database or go by the reports and case studies Litman’s teams develop. And they’re in good company: Most of the world’s top long-term investors follow strenuously cleaned-up accounting, rather than relying on publicly reported financials alone. “The entire Wall Street establishment preaches as gospel an earnings number that’s regarded as nonsense by the top investors of the world,” Litman says, sounding a little like Thomas Paine: “Of the top 300 investors on the planet, 180 read uniform accounting research. Earnings aren’t the bottom line.”
The morning we met, Litman had been lecturing, via Skype, a business school class at the African Leadership University based in Mauritius. A volunteer engagement, the lecture went well into overtime when students got caught in a fever, yelling out companies – “Facebook!” “Tesla!” “Uber!” “Amazon!” – prompting Litman to recall whether they were accurately valued. Correcting for what the rules misrepresent, Facebook and Amazon are even stronger than they look, while Uber and Tesla are just as weak, if not weaker, than reported.
These students were no different, Litman observes, in enthusiasm or expertise – no different from the audiences he addresses at the elite American schools where he lectures throughout the year, or at a recent rave-reviewed engagement at the Harvard Club. His lecture that day was an extended parable about Bruce Lee’s combat philosophy – seriously. “I love the whole Bruce Lee mentality,” he says. “The idea of creating one uniform system of martial arts, the best possible system. That’s what uniform accounting is: Let’s create one set of global accounting standards everybody can understand and get behind.”
Accountants are a put-upon people. They do the math. They follow the rules. Even when they know the rules are wrong, they still follow the rules.
Elsewhere in sports metaphors, uniform accounting fan Dave Daglio of BNY Mellon compares Litman’s uniform accounting to Oakland A’s general manager Billy Beane’s famous Moneyball theory. “Joel’s methods ensure that liabilities, assets, or long-term investments like research and development are calculated correctly – and it provides a clear sense of what a company is doing, particularly how company is doing versus itself and versus peers,” he explains. “If you go to a baseball game and you watch a single game, you might think one hitter is particularly talented because he went three for four, but it’s the long-term numbers that matter.” Understanding how he hits curveballs, fastballs, good hitters, and bad hitters – collecting the data – lets you know which player is actually the best. Litman does the same thing with companies: It’s Moneyball.
If Litman is the Billy Beane (or the Bruce Lee) of accounting, we’re all potential students of his craft. He’s now launching a new initiative that stands to greatly expand his reach: a subscription service to give independent investors access to his analysis and accounting database. It’s nothing if not a teaching tool. It’s the next step in Litman’s mission to mine the true math from the rubble of the broken accounting rules.
Being an accountant, “I’m pretty conservative in nature,” Litman admits: “It wasn’t until several years into my accounting career that I first said, ‘None of this makes any sense.’” Even so, the progression is clear. While working as a consultant, he felt he was able to make more of a difference – showing clients what the financials really meant – but he wanted to publish more widely. On Wall Street, however, no one was really listening.
Over the last decade, Valens’ research has found an eager audience. But it’s an audience limited to top investors and clients of the firm. With his next project – called Altimetry – the idea is bigger. As Litman puts it, “Let’s get this in the hands of Americans!”
“It’s actually a great company: You’ve just got to look at Note 19 on page 78, then you’ve got to look at Note 25 on page 140 – and if you’re not looking at that detailed level, you’re not going to see the true numbers.”
For long-term investors, choosing the right companies is key. “He’s exposing me to data about companies I never would have looked at before,” says Whitney George, president of Sprott – a global asset-management firm, and a Valens Research client. George tells me he uses Litman’s database not just to monitor companies they own but also to screen for new investments he wouldn’t otherwise notice. And with Altimetry, the extension of similar opportunities to individual investors is an appealing prospect. George – who, along with Dave Daglio, serves on a uniform accounting advisory council Litman founded – has already signed up for the new service.
One unexpected upside of the new venture, he tells me, is its creative demand: Composing a colorful case study for his new subscribers is, in many ways, a richer challenge than pulling together a hard-boiled report for a corporate client.
He and Spivey strolled the Boston Common, chomping on Philippine cigars, while they brainstormed a recent composition: “Florence Nightingale Was a Data Scientist.” It tells the story of the pioneering nurse and social reformer’s often-overlooked impact on the field of biomedical recordkeeping – all as a means of introducing Valens’ study of CVS and Aetna’s new foray into large-scale biomedical data collection.
“He’s spending so much time and energy on this because he has a passion for trying to teach people how to really think about value and companies and strategies of companies,” says Miles Everson, the CEO of MBO Partners and, until recently, the head of global advisory and consulting at PricewaterhouseCoopers. “There’s an authenticity or an honesty and purity about how he sees the world – and the way he makes his money is obviously publishing the information and providing it, but he doesn’t feel slippery.” Everson argues that Litman doesn’t actually try to sell you on the companies he’s choosing to highlight. Instead, he’s just genuinely excited to tell you what he knows.
Individual investors and institutions technically receive the same advice at the same time. The CVS-Aetna analysis, for instance, goes to elite Valens clients and retail investors who sign up for Altimetry. But Altimetry subscribers get an engaging story about a historical heroine who harnessed the power of biomedical engineering, whereas institutional clients get just the numbers and facts. Taking such conventionally inaccessible, tedious, and technical material as the alchemy of accurate accounting and making it not just accessible, but interesting and exciting for a general audience, is the kind of impossible task only a natural teacher would want to take on.
“The teaching continues at every level,” Litman says of the path that’s led him here – and its goal, all along, to find the most efficient way to tell the truth about financial statements. “If I could speak to a million people at once about this stuff, I would.”
Of course, that’s kind of the whole idea: Subscribe, and you’ll be one of them.
American Consequences magazine is pleased to announce that we have partnered with Joel Litman to get access for our readers to his new Wall Street “truth detecting” system. Click here to learn more about his work and how to get free access to his system.
Alice Lloyd is a writer and reporter in Washington, D.C., covering culture, politics, and the weirdness in between. Her work has been featured in the New York Times, the Washington Post, the Boston Globe, and the Weekly Standard.