There are some warn­ing signs that make it un­nec­es­sary to even look at fi­nan­cial state­ments, writes Robert Laing

Financial Mail - Investors Monthly - - Contents -

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.

Pic­ture: iSTOCK

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