I was recently introduced to an article by a reader on the M Score and have found it quite interesting and wanted to share it with you as well. I’ve summarized and edited parts of the original article.
The M score was created by Professor Messod Beneish. In many ways it is similar to the Altman Z score, but optimized to detect earnings manipulation rather than bankruptcy. This is the link to the original M score for earnings manipulation paper.
Beneish used all the companies in the Compustat database between 1982-1992.
The M score is based on a combination of the following eight different indices:
DSRI = Days’ Sales in Receivables Index
GMI = Gross Margin Index
AQI = Asset Quality Index
SGI = Sales Growth Index
DEPI = Depreciation Index
SGAI = Sales, General and Administrative expenses Index
LVGI = Leverage Index
TATA - Total Accruals to Total Assets
The eight variables are then weighted together according to the following:
M = -4.84 + 0.92*DSRI + 0.528*GMI + 0.404*AQI + 0.892*SGI + 0.115*DEPI – 0.172*SGAI + 4.679*TATA – 0.327*LVGI
A score greater than -2.22 indicates a strong likelihood of a firm being a manipulator. In his out of sample tests, Beneish found that he could correctly identify 76% of manipulators, whilst only incorrectly identifying 17.5% of non-manipulators.
The five variable version excludes SGAI, DEPI and LEVI which were not significant in the original Beneish model.
M = -6.065 + 0.823*DSRI + 0.906*GMI + 0.593*AQI + 0.717*SGI + 0.107*DEPI
In 2008, Beneish goes into more detail in another paper that he published titled “Identifying Overvalued Equity” which seeks to use the M score to select stocks.
Beneish examines portfolio deciles based around his M score over the period 1993-2003 with annual rebalancing done four months after the financial year end.
The results produce 14% for the 8 variable model and 14.8% for the 5 variable M score version where the top M score stocks were held long while the lowest M score stocks were shorted.
This article wouldn’t be complete without a supporting spreadsheet of course.
You can download a spreadsheet that will automatically pull in the required financial data to calculate the Beneish score for the prior 2 years and TTM. Both the 5 variable and 8 variable version of the M score is included.
To download the spreadsheet, sign up to Old School Value with email at the email form right at the bottom of this page.
You will receive a list of all the other free spreadsheets, the excel add-in from the SMF group required to download data from the internet as well as all the installation help material.
Feel free to check out the free version and then when ready, go to the stock valuation software page and review what you will get with the premium.
The premium version includes several valuation models as well as fundamental analysis data, historical data, charts and competitor comparison features. Just by entering one ticker, you can immediately get all that information on your favorite stock which will save you hours in your analysis.