Below are the notes from Valuepickr Mumbai session on 13th November 2016
Many thanks for Dhiraj bhai (Dhiraj Dave) for presenting “Reading between the lines” (what to read in an annual report of any company that you are currently looking forward to invest)
I have made a brief summary, i may have missed some points, please feel free to add
- Check the change in name of the company over the period of last 10-15-20 years. Rogue promoters will typically have a trend similar to below
Early 90 - NBFC
Late 90 - IT Company
Early 2000 - Infra
2010 - Healthcare company
Above is a trend of a promoter who is just trying to ride the wave and is not into serious business
- Has the Company issued FCCB in last few years? If Yes, what have been the proceeds used for? Capital Expenditure or acquisition of a foreign company at a high valuation? The later is a sign of a cunning promoter wanting to siphon money off. 90% companies would have acquired a foreign company at obscene valuations where goodwill is more than 30-40% of the networth. Funding a bad company acquisition that too on debt is a poor idea, he could have used equity to obtain capital
- When you see rising share prices and rising profits, you would like to know, whats really happening? Nowadays companies dont disclose the volume and revenue growth both at same time. Thus one finds it difficult to check the company’s capacity utilization and scalability. One proxy to that is increase in power consumption. Any good mfg. company would see a sequential rise in power consumption. For pharma companies, one can see sequential rise in R&D expenses over a period of time
- Please check for SEC filing details of a company that has presence in USA. Companies that usually dont disclose too many details in their Indian filings, do so in SEC filings.
- For banks, check what is the size of their deposits and how many of their customers make up their total deposits ?
- It is worthwhile checking the number of pending legal cases against any company; use sources like legalpundits.com. Any company into serious operations would naturally have some active legal cases. However that gives you an idea that the company is actually doing that business and not faking facts
- Balance sheet - Fixed Assets
Look for how much of gross block is made up by Plant & Machinery. In any mfg. company, plant & machinery would constitute about 50-60% or even more. If this num is seriously low, you have a reason to query. Check both consolidated & standalone nos. to verify these facts
- Also check related party transactions for that company to whether any loss making companies are being acquired & run by using the profits from this company
- Check whether the brand/trademark is owned by the company or its promoters. If it is owned by promoters, its a red flag for you, because in such cases, the promoters will keep drawing annual royalty from the company’s profits
- Check whether the company is empanelled or blacklisted in some of its reputed customer panels ? For e.g. if its an EPC company, then is it empanelled or blacklisted by reputed customers like ONGC ?
- Check whether the company has been making increasing investments into loss making subsidiary; thats a red flag and analysis of standalone and consolidated nos will make this clear
- Balance sheet - Current Assets
Check for Loans and Advances recoverable in Cash & Kind - these are indeed doubtful practices and if used frequently must give rise to doubt
- Balance Sheet - Capital
If preference capital or Share application money remains on the books for many years in succession, this is a red flag. PReference share holders receive priority in dividend distribution
- Balance Sheet - Reserves & Surplus
If the reserves and surplus are being used for one time merger of a fully owed subsidiary after acquiring it from outside must give rise to questions. Especially so, if the purchase has been capitalized in the consolidated balance sheet
- Balance Sheet - Debts
Increase in no. of bankers and presence of more than 12-14 bankers is a matter of concern
- Entry of a state finance corporation/cooperative bank allowing for exit of a reputed nationalised bank or foreign bank is certainly not a good sign. Especially so if the company has been in the business for long time
- Check for break-up of working capital as a percentage of Sales, if it is about 25% of Sales approx. its OK, but if it is considerably higher, you need to worry
- Check for security offered against loans, has promoter pledged any shares? Or he has offered some special / personal guarantee ? HAs auditor made this a part of their report?
- Check for interest accrued & due in current liabilities - IDeally banks should charge monthly interest and thus the interest accrued and due should be a small number as compared to revenue
- Ideally Revenue should be Nett of sales and trade discounts, if trade discounts have been treated separately, you have to be cautious
- IF for a manufacturing company Value of traded goods sold is higher than manufactured goods sold, you need to check in details, what exaclty is the company’s business model?
- Check for provision for tax, check for provision for doubtful debt, this shouldnt be more than 1% of overall debt
- Check for provision for investment
- Check for extra-ordinary income, especially those resulting from insurance claims. Many fraudulent companies will claim insurance from typical causes like fire to accounting office, fire to R&D building, virus attack on accounting software etc.
- If audit fees have grown significantly over recent past then thats a reason to worry. Also if there has been a frequent change in auditors earlier than 3-5 years, thats another reason to worry
These the the bytes that I could capture from the meeting, I may have made some mistakes in my notes. Please feel free in correcting me wherever you feel I need to be. I am not from accounting background and thus I am open for corrections.