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Detecting Financial Manipulation with the Beneish M-Score

Writer's picture: Tian Khean NgTian Khean Ng

*Plus AsiaPac small caps with good Beneish M-Score

The Beneish M-Score is a quantitative tool designed to detect the likelihood of profit manipulation by businesses. Developed by Professor Messod Beneish, it was introduced in his June 1999 study titled "The Detection of Earnings Manipulation." This model evaluates eight distinct financial ratios, each adjusted by specific coefficients, to assess whether a company might be misrepresenting its financial performance.

Professor Beneish highlighted that firms with rapid sales growth, declining gross margins, increasing operational costs, or growing debt levels are often tempted to misstate their profits. Such manipulations can take the form of prematurely recognizing revenue, deferring expenses, boosting accruals, or reducing depreciation. The eight financial ratios involved in the M-Score are outlined as follows:


  1. Days' Sales in Receivables Index (DSRI): A notable rise in receivable days may suggest a company is recording sales ahead of time to inflate profits artificially.

  2. Gross Margin Index (GMI): A weakening gross margin may indicate unfavorable future performance, prompting companies to manipulate earnings upward.

  3. Asset Quality Index (AQI): An increased proportion of long-term assets—excluding property, plant, and equipment—compared to total assets could signal greater cost deferral efforts aimed at profit inflation.

  4. Sales Growth Index (SGI): While robust sales growth is not inherently fraudulent, companies with rapid growth often face heightened pressures to meet earnings expectations, making them more susceptible to financial misrepresentation. These firms may also seek to prevent sharp declines in stock prices that could arise from slower growth indicators.

  5. Depreciation Index (DEPI): A reduction in depreciation relative to fixed assets could imply adjustments in the estimated useful life of assets or changes in depreciation methods to increase reported income.

  6. Sales, General, and Administrative Expenses Index (SGAI): If SG&A expenses grow disproportionately relative to sales, it may be viewed as a sign of declining business prospects, potentially driving companies to manipulate earnings.

  7. Leverage Index (LVGI): An increase in the ratio of total debt to total assets often pressures firms to meet debt-related agreements, creating an incentive to overstate profits.

  8. Total Accruals to Total Assets (TATA): This ratio measures discretionary accounting adjustments, reflecting the extent to which earnings are influenced by management decisions. Higher accrual levels are typically linked to a greater risk of profit manipulation.


Interpreting the Benish M-Score

Likely Manipulator: An M-Score greater than -1.78 suggests that the company is likely engaging in earnings manipulation.

Possible Manipulator: An M-Score between -2.22 and -1.78 indicates a possible risk of manipulation, warranting further investigation.

Unlikely Manipulator: An M-Score less than -2.22 implies that the company is unlikely to be manipulating its earnings.


Each of these ratios can be calculated using specific formulas, which are accessible via the resource link provided: https://stablebread.com/beneish-m-score/.

While the Beneish M-Score has been widely regarded as a reliable tool for detecting financial manipulation, it is not without its limitations and should not be viewed as infallible.


High Quality AsiaPac Small Caps with Good Benish M Score.

Attached for your download is a spreadsheet of 30 high-quality Singapore, India, Thailand, Indonesia, Malaysia small caps with good Benish Score i.e. <2.22.  The calculation of Beneish M-Score was sourced from www.investing.com . *Not sure why there are no Hong Kong stocks in all my screens so far. The stocks are ranked descending by market capitalization.



The filters for this screen are:


We feature small caps because these are stocks that are more likely to engage in financial manipulation.  Small caps are defined as   stocks having a market capitalization of USD1 Billion. * The stocks here are traded in their local currency but all monetary values have been normalized into USD to make them inter-comparable.

 

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