Hello folks,
Would like to discuss some of the techniques you guys use for the rigorous due diligence.
Companies pays a hefty fees to accountants, and their consultants to find the minute loopholes in accounting to mask the reality. And, all of us are not accountants. Since, the auditors have lost their credibility, we can not trust them for a bit.
So, as a global investor, with average knowledge of accounting, how can we prevent ourself from such companies? How can we asses the quality of their reported numbers? How can we evaluate the quality of internal controls of the business?
I would like to know the red flags you guys looks, for the conviction that there is something fishy going on.
Some of the red flags I use are (Mostly from Financial Shenanigans book):
- Management hiding or just painting some different picture when some specific question asked.
- Unreasonably high margins/profitability, not backed by any source of competitive advantage.
- Indigestible capture of market share in short span of time, without any economic moat or in intense competitive market.
- Massive amount of capital stuck in WC
- Massive amount of cash not yielding anything or just sitting in fudgy banks.
- Capitalizing expenses with the intention to inflate numbers.
- Inspection of revenue sources
- Aggressive selling tactics being used?
- CFO/EBITDA - taxes being consistently below 80% or 120%, inventory levels, receivable levels, unearned revenue, aggressive revenue recognition policies, depreciation
- Negative owner’s earnings with consistency
- Unusual BOD
- Related party transactions
- Unusual compensation/incentive structure
- More and more efforts with intention to please the market
- Consistently reporting margins in line with market expectations (just hitting the bar)
And, doing scuttlebutt to get more sense
Please continue and add ideas for not getting caught in trap…