Can investors rely on financial statements?

Moneyweb

Just how sceptical investors have to be when presented with a set of “facts” was recently highlighted after Steinhoff International admitted that “accounting irregularities” would require its financial statements going back to at least 2015 to be restated.

So, to what extent can fund managers (and investors) rely on audited financial statements when performing due diligence?

Baillie Gifford’s Iain McCombie said fund managers must be cautious. “The fact is if the audit was wrong, the auditors will say ‘well it has nothing to do with us’. You can’t be sued. So, one must be quite sceptical in some respects about the quality of it.”

Investec Asset Management’s Rob Forsyth said while fund managers have to start with the audited financial statements, it’s not the be-all and end-all.

Managers have to do fundamental analysis and consider the risks. His team used various sta- tistical measures and generally didn’t invest in initial public offerings as these firms often didn’t have an adequate track record to examine. It also analysed the cash flow and returns of a business over time to ensure the earnings were backed up by cash flow.

“If you can get some degree of comfort on the return profile and the cash flows the company is producing, you can try and reduce your risk, but outright fraud – it is almost undetectable.”

Schroders’ Alex Tedder said unfortunately managements lie and auditors don’t stop them.

He strongly believes in considering environmental, social and governance factors when analysing companies. Fund managers must spend a lot of time analysing what companies say and cross-checking it.

Asked whether a highly acquisitive company is a warning sign, Kevin Johnson at Dodge & Cox said it could be, but it isn’t always the case, adding it depends on the company, management and industry.

“We would say you learned a lot by looking at history.”