Forensics and the art of triangulation

These are good points. thanks everyone. However, I am very keen on detailing these - I just do not want to brush anything with a broad brush - for eg., high receivables is bad, low CFO/EBITDA is bad etc. unless we can overlay it with an understanding of the business, where cash is used and how it is earned.

I am looking for specific examples, case studies rather than stereotypes as I want to minimize both alpha (not capturing an issue) and beta errors (assuming an issue exists whereas in reality it does not).

For eg., in opto circuits even though acquisition led sales growth was high, CFO’s were consistently negative and receivables were going through the roof, resulting in a cash crunch that ultimately turned debt repayments and investments into a tight squeeze.

Triangulation is about using at least 3-4 data points together to make a judgement to minimize systemic error - not just stereotyping using one single data point.


Hi Vardha,
Thanks for feedbacks and nice to learn from live/old examples than general rules.
However, we need to be very much aware that every company that does something fishy does it in its own in-genuine way. Hence, same game doesn’t get played out in every fraud, but major learning remains same. So, like in opto also, what comes out clear is that receivables were getting high with negative cash flows along & multiple acquisitions (Almost sure shot recipe for disaster). So, with every examples and study we do, its good to highlight broad learnings and thumb rules as takeaways for everyone.
Also, it would be great to test our learning and theory on companies in current situations and discuss which cos can have bleak future and will turn out to be disasters using our learning.
Hope it helps.

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Lets work on some live examples of stocks which are imploding as we speak.

Amtek Auto
Ess Dee

Lets keep the discussion away from the respective stock pages as boarders get too emotional about their holdings.

Looking from a pure analytical point of view, were there any red flags which if noticed could have saved investors a lot of their hard earned money.

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Recently started reading the book “Financial Shenanigans: How to Detect Accounting Gimmicks & Frauds in Financial Reports” to avoid where not to invest.Thought it will be useful for above discussion

Also, found a mini summary of various book points in blog.


Excellent thread @varadharajanr

Forensic diligence is a large part of my investing process. I go by what Harry Markopolos said “Assume fraud until genius is proven”. I prefer taking growth/business/execution/valuation risk and absolutely stay away from corporate governance risk. I am pretty sure despite my best efforts I will still end up investing in companies where management will screw the minority shareholders - largely because there is no full-proof way to address this risk.

I had earlier prepared a broad checklist for reducing corporate governance risk. If I get responses that do not satisfy me on even 3-4 of the below, I assume the worst and stay away.

  1.   Is the auditor reputed or a no-name entity?
       - Ideally, should audit at least a few listed companies.
       - Positive if audits a company known for good corporate governance and creating value for shareholders.
       - Negative if audits only unknown listed entities or companies with known corporate governance issues or does not audit any listed company
  2.   Is the Promoter/management salary reasonable?
       - Is it in range of industry standards and commensurate with the current size/profitability of the company?
       - Does management give itself long-dated warrants free of cost or any other such instrument which hurts minority shareholders?
  3.  Does the company pay taxes?
      - Paying taxes on reported profits is a big hurdle that any fraudulent business needs to cross. If tax payment is 0 (for whatever reason) be skeptical of the profits.
  4.   Has the OCF moved in-line with profitability? At least, over the long run?
      - Has OCF performance been below profitability due to deterioration in WC cycles? Is this too pronounced?
  5.   Has FCF moved in-line with profitability? At least, over the long run?
      - If not, is opex possibly being camouflaged as capex?
      - Is the amount of capex in-line with the business requirements?
  6.   Is Company profitability completely out of line from the industry profitability metrics?
       - If this is the case, does the industry have characteristics of a winner-take-all business model? Is similar characteristics also seen in other geographies where one company makes a lot of money even as the entire industry does bad to ok?
       - Can you explain with simple logic the reason for the out-performance of a single player compared to industry? Are you confusing a horse that counts with an exceptional mathematician?
  7.   Does the company have an insatiable appetite for equity capital?
       - The good companies rarely need to raise additional equity capital and definitely not frequently. Typically, equity capital is used to sustain Ponzi schemes.  
       - Has improvement in operating performance happened just before new equity funding? If so, was it a means to attract equity capital and increase valuation?
  8. Is the company over-leveraged? Are Promoter shares pledged?
       - Good companies are never over-leveraged. Inability to reduce debt is potentially a sign that the business does not generate enough “real” cash profits.
       - Promoter pledging is a serious red flag because it incentivizes the company to do everything to keep the stock price high
  9. Does the company have high related-party transactions?
  10. Does the management own other companies which do the same business?

  11. Is the balance sheet odd? Is it in-line with the balance sheet of a typical company in the industry?

  12. Does the management have an empire-builder mindset? Is the company highly acquisitive and prone to continuously entering new businesses (often unrelated)?

  13. Is the Board truly independent or largely comprising friends and family?

  14. Does the company’s cost structure reflect its stated business? For ex. the average employee costs of a company which claims to be in the software product biz should not be similar to a low-end IT services company.

  15. Does the stock price movement or volumes suggest some thing funny? If yes, it could be driven by non-fundamental reasons and often the Promoters tend to be hand in glove in such events. For ex: Look at the price and volume chart of the below company (let me know privately if you are able to figure out the name of the company) which has a market cap of over 2,500 crs. Notice how the volume number barely changes on a weekly basis. A real business will have volumes which have a significantly higher degree of randomness over such a long period of time.

I look forward to adding to my checklist based on inputs on this thread.


Excellent post which takes the discussion forward. My compliments to you.

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A few months back I had written a note on Vakrangee highlighting the red flags. The note was based on the reported financials and some management claims regarding biz economics which were too good to be true. (some of the data may be a few months old)

  1. No Free Cash Flow - While the Company has demonstrated strong earnings growth, the Company has not generated any free cash flow. High earnings growth with continuously -ve FCF is a red flag suggesting that earnings may not be real. Debt reduction that has happened over the last 1 year was also through equity issuance and not internal cash flows.

  2. Increasing Working Capital requirements - Over the last 5 years, Vakrangee’s net current assets have increased from 55 crs to 750 crs (13.5x increase) while sales have gone up from 295 cr to 1950 cr (6.5x increase). WC requirements increasing substantially faster than Sales is a red flag suggesting Sales may not be real.

  3. High capex on government business
    -Vakrangee incurred 228 crs in capex in FY14 (of which 197 crs is for Computers & Printers) towards the e-governance business. Vakrangee continuing to incur high capex for the government business does not make business sense considering the poor economics of the segment and low growth expected by the management.
    -197 crs in capex for computers and printers suggests the purchase of over 20,000 computers in a 1 year period. This number would significantly exceed the company’s employee count (permanent and contracted – Vakrangee incurred 31 crs in employee costs in FY14 and as per the opex breakup does not have significant sub-contracting expenses). The high capex does not match with the current scale of the company’s operations and this is probably opex classified as capex to boost earnings.

  4. Vakrangee Kendra (VK) economics - too good to be true
    -As per management, a typical VK requires very little upfront investment by the company with franchise bearing most of the capex and working capital costs. And a typical VK generates 10 lakhs in annual revenues with the franchise getting 70% share leading to 3 lakhs revenues per VK for Vakrangee. These numbers seem too high and are inconsistent with the realized economics of other companies such as FINO and ALW which have struggled in the BC business.
    -In March 2014, Vakrangee had 3,853 VKs which generated approx. 900 crs in Revenue in the full year. This implies Revenue/VK of 23 lakhs which is substantially higher than the management estimate of 10 lakhs per VK. If we consider that the VK rollout would have happened over the year, the average revenue/VK number would be even higher. These numbers are staggeringly high and hence in all likelihood fictitious.

  5. Exaggerated claims on White Label ATM (WLA) business –
    -Vakrangee has the license to install and operate 15,000 WLAs over a 3-year period (starting January 2014). Management claims the WLA ATM business will be extremely profitable. However, Vakrangee having installed less than a 100 ATMs over the last 14 months is contrary to management claims ( Management claims that they were trying to get RBI permission for new biometric ATM technology and hence the delay. This is difficult to believe considering all the other players (Tata, Prizm, BIT) have already started installing ATMs and now Vakrangee would have to make do with sub-par locations for their ATMs (location is the key driver of ATM transaction volumes). Vakrangee’s lack of progress on WLA ATM deployment is consistent with the market view that the WLA ATM business is economically unviable for most players (
    -Management has guided at installation of 5,000 ATMs over the next 3 months and another 5,000 over the next 9 months. Even the largest ATM players have been unable to achieve such a pace of ATM rollout. This number seems fairly exaggerated. Should be verified 3 months down the line if the company is anywhere close to even achieving its rollout target. (The company had made this claim 3 months back - they haven’t installed even 50 ATMs since then)

  6. Employee count inconsistent with claimed size of operations
    -As per management, Vakrangee currently has 1064 employees (150-200 at the corporate-level, 800-900 at block level for managing 12,000 VKs and identification and deployment of new VKs). The employee count is inconsistent with their current pace of VK rollout (37 per day) and planned ATM rollout (50 per day) over and above their government business. This suggests that the overall scale of operations is much smaller than what the management claims.

The biggest red flag for me at that time was the company’s capex on computers and printers of approx 20 lakhs per employee !!! A clear sign of opex being shown as capex.


@Mantri - maybe you should post your vakrangee note on the vakrangee thread for the benefit of the boarders who are invested in that company.

@Mantri: Superb analysis. Hats off to your clarity and indepth study to identify red flags so specifically.
Great learning for all fellow members.

@mantri - great work. we learn from each other. Find attached something I read recently - read through the entire blog slowly - its quite a revelation.

sort of reminds one of the Yudhishtra’s ashwathama story. there is often a lot of feedback that I get that the company is exporting and I can see the data and hence cash must be real. This a fallacious argument - yes, the company could be exporting and generating cash - BUT, that does not mean that it is generating as much cash as it is showing. You need another data point to figure that out. That’s why it’s called triangulation - you need three independent data points.

Also, your valuation is not a function of sales, profits or EBITDA margins - its a function of free cash flows. That’s something that gets forgotten in pursuit of growth sometimes.

For the record, valeant is a company that has been in the centre of a controversy much like herbalife - no one knows what’s the truth but if you follow the arguments you get to learn a lot.

Trying to put in a case study soon.


Almost all the companies which are hidden gems and almost all which have been doscovered through Valupickr will fail the test of Point 1 and Point 2

Probably thats why investing is an art and not a science.


Any one point alone is probably not sufficient to disprove an investment thesis. If the company fails on several points, then I think we need to be a bit circumspect.

However, I do not know of many companies which have not demonstrated an ability to generate +ve FCF over a long period and yet are “gems”. Companies create value by generating sustainable FCF. I am kinda new here and not aware of the Valuepickr gems that you are referring to.



Dear @ashwinidamani

Can you give us some hidden gems that failed the test of Point 1 and Point 2? We can then learn the conditions under which they fail.

Warm regards,

I was referring to Amit’s post of 12 days ago…Point 1 on auditor and Point 2 on Remuneration

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could you provide examples of Valuepickr hidden gems which failed on Point 1 and Point 2? thanks

[quote=“ashwinidamani, post:31, topic:2580”]
Almost all the companies which are hidden gems and almost all which have been doscovered through Valupickr will fail the test of Point 1 and Point 2

My apologies. I misunderstood.

Dear @ashwinidamani

Sure. On point 2 of remuneration, I think honest promoters may take a high salary and avoid other means of taking fund out of the business - like over invoicing vendors and taking a cash back. So it may also be a plus. I have also seen them reduce their own payout if the business does poorly.

On point 1, if the firm is listed, given the onerous levels of compliance having an unknown audited firm will be suspicious. I use Prime Academy’s research on auditors to find out more about the auditors’ credibility. I know of a large listed entity in Pune which has smaller listed entities. The auditors of the two are different and the smaller entity has an auditor whose credentials in my view are suspect. He could not provide me clarifications on certain items in revenue recognition and my queries on RPTs.

Of course we need to note that an unknown audited firm does not mean ‘dis reputed’. For instance when I was looking at a small firm and called the auditor in Coimbatore, he was extremely clear on how he treated certain transaction, and seemed to have his own ‘independent’ mind.

Ultimately an ‘independent’ auditor’s report should pass the test of independence!

Warm regards,


Without getting into too many argument, all I would say is.

  • Checking independence etc is vague and subjective.

We need to give the management benefit of doubt. Unless we hav something blatantly bad, we should not drop ideas due to points like Auditor is a small firm


Is FCF concept Illusive in India? As most of the companies are not FCF positive? Isn’t OCF is better matrix to judge the company?

Please suggest your views




Dr vijaymalik has very well written an article on ’ Gimmicks used by managements’, it would certainly help to understand the ways and means the managenments uses in laundering the balancesheet,P/L and cash flow statements.

According to the article FCF is better matrix to judge the company rather OCF because it can also be manipulated.

Check out at

hope it helps



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