Tag: quantitative value

Messod Beneish, a professor at Indiana University’s Kelley School of Business, outlined a quantitative approach to detecting financial statement manipulation in his 1999 paper The Detection of Earnings Manipulation. (pdf) He based his model on forensic accounting principles, calling it the “probability of manipulation,” or PROBM model.

The model correctly identified, ahead of time, 12 of the 17 highest-profile fraud cases in the period 1998 to 2002. The PROBM model also consistently predicted stock returns over 1993 to 2007. Students from Cornell University, using the PROBM, correctly identified Enron as an earnings manipulator, while experienced financial analysts failed to do so.

Looking through balance sheets from 2010-2013, the companies with the least probability of manipulation are:
LGBFORGE [stockquote]LGBFORGE[/stockquote]
DISHTV [stockquote]DISHTV[/stockquote]
EROSMEDIA [stockquote]EROSMEDIA[/stockquote]
TATACOMM [stockquote]TATACOMM[/stockquote]
HERITGFOOD [stockquote]HERITGFOOD[/stockquote]
SUPERSPIN [stockquote]SUPERSPIN[/stockquote]
ASAL [stockquote]ASAL[/stockquote]
VIMTALABS [stockquote]VIMTALABS[/stockquote]
PIRGLASS [stockquote]PIRGLASS[/stockquote]
RIIL [stockquote]RIIL[/stockquote]

Since the PROBM score is more of a gatekeeper, here’s a slightly longer list of stocks with high PROBM score:

ASHIANA [stockquote]ASHIANA[/stockquote]
IDFC [stockquote]IDFC[/stockquote]
TUBEINVEST [stockquote]TUBEINVEST[/stockquote]
BAJAJFINSV [stockquote]BAJAJFINSV[/stockquote]
PTC [stockquote]PTC[/stockquote]
SHRIRAMCIT [stockquote]SHRIRAMCIT[/stockquote]
MAGMA [stockquote]MAGMA[/stockquote]
GODREJPROP [stockquote]GODREJPROP[/stockquote]
BAJAJCORP [stockquote]BAJAJCORP[/stockquote]
SRTRANSFIN [stockquote]SRTRANSFIN[/stockquote]
SGJHL [stockquote]SGJHL[/stockquote]
THANGAMAYL [stockquote]THANGAMAYL[/stockquote]
MANAPPURAM [stockquote]MANAPPURAM[/stockquote]
SREINFRA [stockquote]SREINFRA[/stockquote]
CHOLAFIN [stockquote]CHOLAFIN[/stockquote]
M&MFIN [stockquote]M&MFIN[/stockquote]
LICHSGFIN [stockquote]LICHSGFIN[/stockquote]
BAJFINANCE [stockquote]BAJFINANCE[/stockquote]
L&TFH [stockquote]L&TFH[/stockquote]
PFS [stockquote]PFS[/stockquote]

Note: we ignored stocks that don’t had 5 years worth of statements.

The PROBM score, along with SNOA and STA, allows us to screen for stocks with strong balance sheets. We’ll put these three together in the next post…

The intuition behind SNOA as a filter is that firms with a high level of net operating assets, scaled to control for their size, indicates a lack of sustainability of recent earnings performance. An accumulation of accounting earnings without a commensurate accumulation of free cash flows raises doubts about future profitability. If investors have limited attention and fail to discount for the unsustainability of earnings growth, then firms with high net operating assets will be overvalued relative to those with low net operating assets. In the long run, such mispricing will on average be corrected. This implies that firms with high net operating assets will on average earn negative long-run abnormal returns, and those with low net operating assets will earn positive long-run abnormal returns. The whole paper is worth a read: Do Investors Overvalue Firms with Bloated Balance Sheets (pdf)

The idea is that you go long stocks with low SNOA and short stocks with high SNOA. Going past 5 years, here’s a list of stocks with a low SNOA:

NMDC [stockquote]NMDC[/stockquote]
ORISSAMINE [stockquote]ORISSAMINE[/stockquote]
MOIL [stockquote]MOIL[/stockquote]
ENGINERSIN [stockquote]ENGINERSIN[/stockquote]
INFY [stockquote]INFY[/stockquote]
INGERRAND [stockquote]INGERRAND[/stockquote]
OFSS [stockquote]OFSS[/stockquote]
OIL [stockquote]OIL[/stockquote]
NAUKRI [stockquote]NAUKRI[/stockquote]
COALINDIA [stockquote]COALINDIA[/stockquote]

And the ones with high SNOA:

HALONIX [stockquote]HALONIX[/stockquote]
ESL [stockquote]ESL[/stockquote]
VGUARD [stockquote]VGUARD[/stockquote]
HITECHPLAS [stockquote]HITECHPLAS[/stockquote]
TIRUMALCHM [stockquote]TIRUMALCHM[/stockquote]
TTML [stockquote]TTML[/stockquote]
BIRLAERIC [stockquote]BIRLAERIC[/stockquote]
BURNPUR [stockquote]BURNPUR[/stockquote]
SURANAVEL [stockquote]SURANAVEL[/stockquote]
DIGJAM [stockquote]DIGJAM[/stockquote]

Note: we ignored stocks that don’t had 5 years worth of statements.

When you combine STA (discussed earlier) and SNOA, you get to a place where you have filtered a vast majority of the universe. But there’s one more gatekeeper to discuss…

Usually, analysts fixate on the “net income” part of the income statement. However, operating cash flow is the lifeblood of a company and is a better metric of a company’s financial health for two main reasons. First, cash flow is harder to manipulate and second, a company that does not generate cash over the long term is on its deathbed.

One of the measures of balance sheet bloat is scaled total accruals (STA). STA = (net income minus cashflow from operations) divided by total assets. By ranking STA smallest first, and filtering only for situations where both net income and cashflow are positive, you end up with a list of profitable companies ordered by balance-sheet efficiency.

We aggregated income statements from the past 5 years and ranked companies based on STA. The 10 best:

BHARTIARTL [stockquote]BHARTIARTL[/stockquote]
EROSMEDIA [stockquote]EROSMEDIA[/stockquote]
USHAMART [stockquote]USHAMART[/stockquote]
ABAN [stockquote]ABAN[/stockquote]
INFRATEL [stockquote]INFRATEL[/stockquote]
WHEELS [stockquote]WHEELS[/stockquote]
ALKYLAMINE [stockquote]ALKYLAMINE[/stockquote]
SUVEN [stockquote]SUVEN[/stockquote]
SUBROS [stockquote]SUBROS[/stockquote]

and the 10 worst:

VINATIORGA [stockquote]VINATIORGA[/stockquote]
ICRA [stockquote]ICRA[/stockquote]
NAVNETPUBL [stockquote]NAVNETPUBL[/stockquote]
AIAENG [stockquote]AIAENG[/stockquote]
ECLERX [stockquote]ECLERX[/stockquote]
HERCULES [stockquote]HERCULES[/stockquote]
IMPAL [stockquote]IMPAL[/stockquote]
MOIL [stockquote]MOIL[/stockquote]
WABCOINDIA [stockquote]WABCOINDIA[/stockquote]
BLISSGVS [stockquote]BLISSGVS[/stockquote]

Note: we ignored stocks that don’t had 5 years worth of statements.

The problem with a stand-alone STA measure that it doesn’t track changes in balance-sheet health. More on that later…

Book Value to Market Value (BtM) is the ratio of the firm’s Book Value to the Market Price of Equity. Book Value is simply total assets minus intangibles and good will and Market Price is the total common shares outstanding times the market price of the stock.

The problem with the BtM ratio is that it tends to pick stocks that are under attack. However, its an useful measure to make an apple-to-apple comparison between stocks within the same sector.

When we ranked the universe of stocks using BtM, it obviously threw up a lot of stocks that have been hammered down:

SELMCL [stockquote]SELMCL[/stockquote]
MICROTECH [stockquote]MICROTECH[/stockquote]
GAMMONIND [stockquote]GAMMONIND[/stockquote]
UNITEDBNK [stockquote]UNITEDBNK[/stockquote]
UBHOLDINGS [stockquote]UBHOLDINGS[/stockquote]

What’s more interesting is what made the bottom of the list:

DABUR [stockquote]DABUR[/stockquote]
ZYDUSWELL [stockquote]ZYDUSWELL[/stockquote]
BAJAJCORP [stockquote]BAJAJCORP[/stockquote]
TCS [stockquote]TCS[/stockquote]
EMAMILTD [stockquote]EMAMILTD[/stockquote]
HINDUNILVR [stockquote]HINDUNILVR[/stockquote]
GODREJCP [stockquote]GODREJCP[/stockquote]
PAGEIND [stockquote]PAGEIND[/stockquote]
COLPAL [stockquote]COLPAL[/stockquote]
SPARC [stockquote]SPARC[/stockquote]

So basically, the more ‘popular’ the stock, the less of a ‘value’ it is, at least according to BtM. Also, when you work with annual balance sheets later in the year, most of the information tends to be fully priced-in.