There are some warning signs that make it unnecessary to even look at financial statements, writes Robert Laing
Trying to identify winning companies by reading financial statements is extremely difficult. We give you pointers on how to spot a firm to avoid
Trying to identify winners by reading financial statements is extremely difficult, something even talented experts manage to get right maybe only half the time.
Weeding out losers, on the other hand, is fairly easy. Often, you don’t even have to bother looking at what a deadbeat company’s financial statement says. Just looking at when it appears gives you all the warning you need.
A topical recent example to illustrate this is the Gupta-family-owned Oakbay Resources & Energy. Its results for the year ended February 28 were released on June 2.
An immediate red flag here is that Oakbay missed the JSE’s three-month deadline by two days. The JSE typically gives companies a month’s leeway before issuing a statement saying: “The JSE advised that [insert company name here] has failed to submit provisional reports within the three-month period stipulated in the JSE’s Listings Requirements. Accordingly, the company’s listings on the JSE TradElect system have been annotated with an “RE” to indicate that the companies have failed to submit their provisional reports timeously and that the listings of the company’s securities are under threat of suspension and possible ter- mination. Should the companies still fail to submit their provisional reports by [the last day of the current month] their listings will be suspended. This announcement has been placed by the JSE in the interest of shareholders.”
Holding shares in a suspended company is fairly disastrous, because you get stuck with a zombie entry in your broking account that you cannot get rid of.
A simple self-defence rule for retail investors is to never touch shares which are or have ever been annotated with “RE”, and to immediately bail out of a company whose tardy management releases its results at the last minute.
The day of the week, along with the time, when results statements appear on Sens provide further clues.
Note that June 2 was a Fri- day. Not only that; Oakbay released its results at 5:25 pm on a Friday, when most market watchers would be in the pub.
However, releasing results on a Friday after the market closes is not necessarily evidence you are dealing with a dodgy company. For instance, Warren Buffett’s Berkshire Hathaway has a policy of always releasing its quarterly results late on Fridays so that investors have the weekend to digest them.
The key point is that wellmanaged companies tell their shareholders when their results will be released months in advance, and tend to put them out at 7 am on that day, even though that does sometimes cause knee-jerk reac- tions of the share price moving sharply up or down until punters realise the numbers are not as good or as bad as they initially appear.
Also pay attention to when a company releases trading statements — and the time gap between the trading statement and the financial results.
The JSE’s rules require companies to issue the statements once they are aware that their earnings will differ by more than 20% from the matching period’s. Well-managed companies tend to release trading statements within a few days of their financial year end and weeks ahead of their results. Many blue-chip companies issue voluntary trading statements even if their earn-
ings are not going to differ by more than 20% so as to notify shareholders of the date their results will appear.
Companies whose shares you want to avoid make a habit of releasing trading statements only a few hours before awful results, which, in turn, either miss or barely make the deadline set by the JSE.
Back to Oakbay. Its trading statement appeared a day before its results, which sprang the bad news that its headline loss per share would widen to 5.89c from the prior year’s 0.68c. So the second red flag is that Oakbay’s management appears to have been unaware that its results were going to worsen by 766% until they pulled an all-nighter to get them out.
Another handy trick to reading results statements and other corporate communications is to work from the bottom up. One reason for this is that companies tend to put their marketing puffery at the top and bury important information towards the end of their statements.
The last bit of information typically found in a Sens statement is the name of the sponsor. Investors generally only learn to pay attention to the name of the sponsor the hard way — as in the case of those unfortunate enough to have subscribed for any of the five initial public offerings organised by the now defunct Arcay Moela Sponsors a decade ago.
The dogs that Arcay brought to market included Pinnacle Point, IFCA Technologies and Ububele.
Names you want to see are Deutsche Bank, PwC Corporate Finance or Nedbank Capital.
Oakbay put sponsors back in the news recently when River Group gave notice it no longer wanted to be associated with the Gupta family’s mining group. Oakbay is once again battling to find a sponsor — which along with an accredited auditor is a listing requirement set by the JSE — after Sasfin Capital handed its notice to Oakbay at the same time that auditors KPMG quit with immediate effect.
An important paragraph that tends to be near the end of financial statements is the auditors’ opinion.
It is quite common for struggling companies to have current liabilities outrunning current assets, in which case the audit opinion includes an emphasis of matter (which the JSE highlights by annotating the share with an “E” in its TradElect system) saying there is uncertainty about the company’s going concern status.
SizweNtsalubaGobodo’s audit opinion of Oakbay not only included an emphasis of matter on going concern conditions, it included something I’ve never seen before: “In accordance with their responsibilities in terms of section 44(2) and 44(3) of the Auditing Profession Act (APA), the independent auditors have identified a reportable irregularity in terms of the APA. They have reported such matter to the Independent Regulatory Board for Auditors.”
As someone with only a sketchy knowledge of accounting, I’m not sure what a reportable irregularity is, but it doesn’t sound good.
A company’s stand on audit rotation is another handy way to guess whether it is an attractive prospect or not. A fresh set of eyes looking at the books every 10 years or so is likely to keep management honest, and honest management will appreciate the value of regularly rotation auditors for its investors and creditors.
Those companies currently lobbying hard against the introduction of mandatory auditor rotation are bound to be hiding something. The most vocal opponent of mandatory auditor rotation happens to be Naspers, which coincidentally has a habit of sneaking out bad results late on Fridays.