Hot on the heels of the can of worms that was Quindell currently the subject of a Serious Fraud Office investigation comes the downfall of another AIM company that was hugely popular with retail investors: Globo (LSE: GBO).
The international provider of Enterprise Mobility Management, mobile solutions and software as a service was the subject of a damning report from a small US hedge fund published last week by AIM vigilantes ShareProphets.
Yesterday, shareholders awoke to devastating news from Globo itself that chief executive Costis Papadimitrakopoulos had resigned, having brought to the attention of the Board certain matters regarding the falsification of data and the misrepresentation of the Companys financial situation.
Ive written negatively about Globo in a number of articles over the past year, so heres my checklist of some of the key warning signs of a potentially dodgy company. Ill begin with accounting red flags and move on to danger signals that can be spotted by even the most inexperienced investor.
Revenue and profit. Aggressive or fraudulent booking of revenue and profit may be indicated by a high level of trade receivables, other receivables and other current assets on the balance sheet. In Globos last financial year, these entries totalled 76m, equivalent to 72% of the companys 106m revenue.
Cash flow. Companies indulging in aggressive accounting or fraud will typically try to push as much negative operating cash flow as possible down into the investing cash flow section of the cash flow statement in order to inflate the operating cash flow number. Under accounting rules, capitalisation of costs is open to abuse. Be wary of high and rising purchases of intangible assets in the investing cash flow section and ballooning intangible assets on the balance sheet (from 5m to 45m between 2007 and 2014 in Globos case).
Cash in the bank. Cash-rich companies may have some borrowings for all sorts of reasons, but Globo has maintained a bizarre balance sheet in this area. At its latest half-year end, Globo reported cash of 104m (on which its was earning minimal interest) and a whopping 57m of borrowings (on which it was paying substantial interest).
Raising cash. Despite that net cash of 47m, Globo announced it was looking to issue expensive junk bonds (to raise $180m), ostensibly to fund acquisitions. This seemed at best an ill-conceived idea and at worst an indication that the strong cash position at the company might not be all it appeared. Companies claiming to be cash-rich, but employing or raising large amounts of expensive debt is not a good sign.
Unbelievable value. Globos shares were suspended from trading last week at 28p. The current-year forward price-to-earnings (P/E) ratio was 3.4 and the P/E-to-earnings growth (PEG) ratio was 0.15. On these popular ratios with retail investors Globo appeared to be the steal of the century. However, a company growing earnings as fast as Globo claimed to be simply shouldnt have these kind of bargain ratings. Far from seeing an opportunity to fill your boots, investors should view patently and extremely inappropriate P/E and PEG ratios as a warning sign. As the saying goes: if something looks too good to be true
Financial website discussion boards. Beware of company boards with large excitable armies of followers. These are typically either blue-sky story stocks that often crash-and-burn, or companies such as Globo where unwary retail investors have been sucked in by those irresistible P/E and PEG ratios I mentioned.
Short sellers. The Financial Conduct Authority has a webpage from which you can access a daily spreadsheet listing stocks in which there are significant short positions. Short sellers, who profit from a falling share price, can be vulnerable to suffering far bigger losses than investors who are long. As a result, short sellers tend to do considerably more due diligence on a company than the average long investor. A heavy and persistent presence of short sellers of a stock should not be overlooked lightly.
Finally, youll never have conclusive proof a company is a fraud, because, if you had, its shares would already be worthless. But the more red flags there are, the higher the risk. Why chance your arm when there are so many other companies out there that arent festooned in red bunting?
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G A Chester has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.