Here’s what I do… I look at how the company handles depreciation and amortization of its assets. If management is trying to inflate earnings, it is highly likely that management will be aggressive in making aggressive estimated useful life assumptions behind D&A.
- It’s really obvious to the accountants that they can inflate earnings by making more aggressive assumptions here.
- Pulling this lever is perfectly legal since these assumptions are inherently uncertain and therefore subjective. No one will go to jail for pulling on this lever.
- All companies have to make assumptions on this accounting topic.
Here are some shortcuts that I use to quickly figure out a stock.
- Mysterious price spikes on high volume and little/no news. Sometimes, these coincide with stock promotion like an email blast, physical mailers arriving, etc. etc. A stock that has many of these spikes is probably an egregious pump and dump.
- The stock IPOed during the Dot-Com era and has been on a slow decline since. Usually these Dot-Bomb wreckages are a decent place to look for shorts. A lot of questionable stuff went public during the Dot-Com boom. Such stocks have a tendency to stay somewhat questionable. Pedigree matters.
- The share price performance since inception isn’t very good. Usually a sign of a bad or mediocre underlying business.
(*Disclosure: I am short.)
Hollysys is a Chinese company that designs high-tech stuff. Interestingly enough, they were able to grow revenues, profits, and operating cash flow without having to increase capex. See the chart on the left from page 31 from the latest investor presentation: