A short article lists 5 "red flags" for finding shortable companies. These are sort of criteria but they're not as concrete and straight forward as the sorts of things we discuss in the other thread so I thought it deserved its own thread. I still haven't gotten around to reading the Beneish papers yet so there may be some overlap there (just at first glances).
To get a copy of this (and 2 other pdfs) go here and enter your email address. You will get the occasional spam from fool.com promoting their new shorting service but otherwise it's harmless.
The summary:
1. Accelerated Revenue Recognition – The idea here is that companies may use tactics of writing down purchases today where delivery of the product doesn't occur for some time. The company, in attempt to inflate revenues, may offer customers deals to buy and lock in today to receive an item at a later date. This inflates current revenues without having extra costs.
2. Weakening Cash Flow – Here companies will have strong earnings growth but weak or negative operating cash flows. The idea is the company inflates its earnings via accounting tricks and the goal is to detect it.
3. Unusual changes in Profit Margins – The idea here is that there may be some accounting trickery going on here making profit margins (hence, earnings) look better than they actually are.
4. Highly Acquisitive Companies – The acquired companies and its assets can be used for more accounting trickery.
5. Changes in Reporting – If the company changes some aspect of how they report financial information this indicates that the company may be doing so to make their financial statements look better than they are.
There's more detail in the pdf if you choose to read it. They're all just "red flags" and should be cause for concern or further investigation.
The article is written by John Del Vecchio who is heading up fool.com's shorting service. He basically suggests that these "red flags" are good both for identifying short candidates and for weeding out problematic companies from your long portfolio. As an interesting side note, he thinks the future of GE and IBM is grim based on these companies (he claims) exhibit some of the red flags that he looks at.
He developed an EQ-model which is an attempt to evaluated the earnings quality of the company. From what I can tell it's going to be offered to those who join fool.com's short service (which I'm guessing will cost a pretty penny.) I'd be curious to know how it relates to Beneish's M-Score; I would imagine there will be similiarities.
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