By Howard M. Schilit and Jeremy Perler
Today I am continuing my in-depth review of Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports. This is an ongoing process, so send me your feedback as to how I can provide you with more value in reviewing these books (send me an email here or leave a comment below).
You can read the other parts of this review here. Stay tuned each Saturday and Sunday for the next parts of this review.
Part One: Establishing the Foundation
The first part of this book contains two chapters where the author lays the foundation for how to think about financial shenanigans.
Chapter 1: As Bad As It Gets
Chapter one presents a sort of “Worst of the Worst” list, with profiles of some of the most notorious examples of financial shenanigans. The authors present the usual suspects, whose shenanigans were so audacious, so unequivocally wrong, and so harmful to investors that their cases are known worldwide, their executives tried daily in the media and in some cases, regulators around the world enacted new rules to minimize the likelihood of these frauds reoccurring (though, we are seeing today with the Chinese RTO situation that regulators are in a cat-and-mouse game with fraudsters willing to change their tactics).
Though you have undoubtedly already heard of many of these companies, including Enron, WorldCom and Tyco, there are a few you probably haven’t heard of, like Symbol Technologies (a manufacturer of bar code scanners which the authors say used all of the shenanigans in outlined in the book!). Additionally, even for the companies you have heard of, you may not be aware of exactly how their financial shenanigans worked, or possibly the full extent of what they were doing. This is a pretty short chapter, and gives a quick introduction to how bad things can get.
One of the big takeaways of this chapter is that investors need to be wary of stories that are too good to be true. For example, the story of Enron often revolves around their use of murky off balance sheet partnerships, but the authors contend the issues were clearer than that. The company reported 10x revenue growth from 1995 to 2000. While this in itself is not shocking, the authors point out that this 10x revenue growth had a baseline of $10 billion revenue, so they went from $10 billion to $100 billion. Only a small handful of other companies have every accomplished this feat (The $10 billion to $100 billion range is apparently akin to the 26,000 ft+ level in mountaineering – the “death zone” where few are able to survive), and those companies that have accomplished that kind of revenue growth have done so after decades. After Enron, Wal-Mart was the next fastest company to accomplish this, and it took them 10 years! Unfortunately, most investors took this rapid revenue growth at face value rather than considering this a red flag for further investigation of potential revenue shenanigans.
Another example is how Symbol Technologies reported earnings that exceeded estimates for 32 straight quarters. Similar to the Madoff scheme, investors should be wary of stories that are too good to be true and investigate further.
Author Disclosure: This book was provided by the publisher