The Beneish M-score, now about 17 years old, is well known in accounting and fundamental investing circles as a method of assessing the likelihood of financial manipulation. It came to attention mainly due to its having flagged Enron as a fraud in waiting. Had it been around in the mid 1990s when Healthsouth were being naughty capitalizing expense items it would have flagged them too.
It’s simple to calculate from published financial statements and some financial websites even do it for you. It is a metric that lends itself, especially in combination with other data, to the long/short trading process.
Although the main goal of this "To catch a thief" paper was to test the M-score in an out-of-sample analysis (which indeed validates Beneish’s model) it also lays out a few ways how such combinations can enhance the potency of the ratio.
In issue #5
of this newsletter we covered one such complementary ratio, percentage accruals. The sections of this paper covering the relationship between it and the M-score are particularly valuable to long/short traders.
Of course, context matters greatly and establishing it can take some digging. But in an era where the accounting data is free and readily available from the Securities and Exchange Commission’s website that is a small cost to bear.