The course uses many examples to build pattern recognition among students. We see little advantage in teaching how to calculate the Beneish M-Score (a popular indicator of earnings manipulation), as it is readily available on Bloomberg or in a spreadsheet. Instead, we focus on why it works, how it’s constructed, show its performance and flag current offenders. We then give examples of how companies manipulate earnings for each parameter in the M-Score. The benefit to students is they understand the philosophy and can better spot similar examples in future. It also makes for a more interesting course.
“After the long 1990s bull market, there was an explosion of accounting frauds, starting with Enron, and which did not finish with Tyco – this cycle will be no different”
We believe that at the end of a long bull market, we shall see a repeat of the series of frauds uncovered at the end of the tech boom. We believe that it could be worse now, as executive compensation encourages manipulation, auditors have become more sloppy, sell-side analysis has become “juniorised”, and company accounts are even more complicated.
We see this as likely to be most prevalent among small-caps but large caps are by no means immune and we believe that some highly rated glamour stocks will be exposed in the next downturn.
We show below a sample slide from the course which illustrates that sometimes Finance Directors can be overly conservative. Here we are looking at changes in accounting estimates and we illustrate how variations in warranty provisions can be used to boost margins and earnings, or in this case to depress them.