Using Beneish M Score to detect potential financial manipulation

In fundamental analysis, besides looking for the potential earning growth of the company, one has to ensure that the company financial position is healthy.  However, analyzing the company financial statement is not an easy task for many retail investors; one has to go thru many years of annual reports analysis, reading the financial notes and understanding the details of each entry in the financial statement.  Often, the process is very time consuming.

In 1999, Dr. Messod Beneish, an accounting professor at Indiana University’s Kelly School of Business published a research paper called “The Detection of Earning Manipulation”.     He introduced a simple analysis method, the Beneish M Score, to detect potential financial manipulator by using information that is readily available in the financial statement.

The Beneish M Score is calculated using eight financial ratios with different weightage.

M Score= -4.840 + 0.920DSRI + 0.528GMI + 0.404AQI + 0.892SGI + 0.115 DEPI - 0.172SGAI + 4.697TATA - 0.327LVGI

where,

1.       DSRI = Days Sales Receivables Index

2.       GMI = Gross Margin Index

3.       AQI = Asset Quality Index

4.       SGI = Sales Growth Index

5.       DEPI = Depreciation Index

6.       SGAI = Sales, General, Administrative Expenses Index

7.       TATA = Total Accruals to Total Assets

8.       LVGI = Leverage Index

One can easily construct the Beneish M Score model using Excel spreadsheet.  Table 1 shows the Beneish M Score model for INTC.

Table 1

For M Score that is smaller than -1.78 (more negative) is classified as non-manipulator.  Whereas for M Score that is larger than -1.78 (moving towards zero or positive numbers) is classified as potential manipulator.

The below table (Table 2), shows the M-Score for various companies using the excel spreadsheet method.

Table 2

Company	Beneish M-Score
	2015	2014	Benchmark
TEOSENG	0.399121	-2.88335	Normal < -1.78 < Cautious
PENTA	-1.70263	-2.66321	Normal < -1.78 < Cautious
OKA	-2.48998	-2.70577	Normal < -1.78 < Cautious
HOMERIZ	-2.55859	-2.8873	Normal < -1.78 < Cautious
TIMECOM	-2.78086	-2.60162	Normal < -1.78 < Cautious
INTC	-2.8429	-2.90393	Normal < -1.78 < Cautious

There are two companies getting M-Score that are larger than the benchmark -1.78.  The results suggest that these two companies may have higher chances than other in manipulating their financial statement.  As such, investors shall put more effort in studying their financial statement. 

Table 3 shows the M-Score details for TEOSENG.

Table 3

It is very obvious that the large M-Score is mainly contributed by the AQI.  Looking at TEOSENG Balance Sheet on 2015 Annual Report (Figure 1), there is RM931,106 recorded under Investment property.  In notes 7 (Figure 2), it states that this RM931,106 is represented by Leasehold Shophouse. 

According to the definition in the annual report, investment properties are properties held either to earn rental income or for capital appreciation or for both.  As the amount is not significant compare to general property purchase or expenses, my personal guess is probably the management bought a property for production or supply of goods, while a small portion of the property were rented out to earn rental income.  But it is more appropriate to ask this question to the management during AGM.

Figure 1

Figure 2

Table 4 shows the M-Score details for PENTA.

Again, the most significant contributor is the AQI.  Looking at the Balance Sheet of PENTA 2015 annual report (Figure 3), there is an intangible asset of RM10,856,140 recorded.  A quick look on Note 6 (Figure 4) indicates that majority of this amount is coming from the newly acquired subsidiary Origo Ventures (M) Sdn. Bhd.’s project management right.

According to the annual report, Origo Ventures is a property project management company.  The reason for this acquisition is to align with PENTA future development on Smart Home and Building Solutions.  As the acquisition was carried out at a bargain using cash, PENTA booked a profit of RM2,595,407 but recorded a lower cash flow from operating activities.  As a results, the 2015 TATA score is inferior to 2014 TATA score.

Table 4

Figure 3

Figure 4

Personally, I do not see any strong linkage between property project management activities and Smart Home solution development. The management did not provide any detail on the plan in the annual report.  Investors may want to post this question to the management during AGM. 

Disclaimer:  The above analysis does not imply any buy or sell recommendation.   The author disclaims all liabilities arising from any use of the information contained in this article.