Thank you for the insightful summary. I wonder how we get the list of companies after the first filter criteria shared by Pulak, i.e., how do I filter the companies using the following criteria, considering these seem to be qualitative criteria and can't be added as a filter in a database (say from Tijori):
Hi Prashant, thanks for the comment. Most of those cannot be filtered unfortunately. However, low debt levels (debt to equity ratio less than 0.5) and high sustained ROCE of 20%+ over many years shows that the management is prudent with their capital structure and acquisitions and also are in a pretty stable industry. However, if they are fudging the numbers or playing accounting tricks to inflate ROCE and show lower debt than reality, then these screeners would falsely indicate that they are quality companies. Only way I've found to verify if the numbers are actually representative is thorough manual due diligence after screening - going through annual reports, management interviews and channel checks etc.
It will be interesting to know more about fudging how the ROCE can be inflated. Fundamentally ROCE is EBIT / Capital employed. Would be great to have insight on how to spot those things with numbers or what rules can be build to check in management commentary specifically to identify sort of check-list in management commentary.
There are a few ways I've seen EBIT artificially inflated: (1) Recording revenue prematurely before all services are completed or products are shipped (2)
Classifying unrealized investment income or one-time gains as revenue (3) capitalizing normal operating expenses (moving them to balance sheet rather than income statement). Also, sometimes too much cash on the books deflates ROCE. If the management will deploy that cash into good projects in the future or return it to shareholders, then it's also useful to remove cash from capital employed to estimate the ROCE (assuming you trust the mgmt to use the cash wisely in the future)
One interesting past example was Indus Towers - when they had high dues from Vodaphone, their ROCE looked like it was dropping. But now that they've been collecting the dues in the last few quarters (for services delivered many months or years ago) , the ROCE looks artificially higher than it would be for "normal operations".
very insightful
This is very useful. Thanks. I would like to speak with you. I am Anand from The Ken. My email is anand@the-ken.com
Thank you for the insightful summary. I wonder how we get the list of companies after the first filter criteria shared by Pulak, i.e., how do I filter the companies using the following criteria, considering these seem to be qualitative criteria and can't be added as a filter in a database (say from Tijori):
- Those owned and run by crooks
- Turnaround situations
- Those with high levels of debt
- M&A junkies
- Those in fast-changing industries
- Those with unaligned owners
Hi Prashant, thanks for the comment. Most of those cannot be filtered unfortunately. However, low debt levels (debt to equity ratio less than 0.5) and high sustained ROCE of 20%+ over many years shows that the management is prudent with their capital structure and acquisitions and also are in a pretty stable industry. However, if they are fudging the numbers or playing accounting tricks to inflate ROCE and show lower debt than reality, then these screeners would falsely indicate that they are quality companies. Only way I've found to verify if the numbers are actually representative is thorough manual due diligence after screening - going through annual reports, management interviews and channel checks etc.
It will be interesting to know more about fudging how the ROCE can be inflated. Fundamentally ROCE is EBIT / Capital employed. Would be great to have insight on how to spot those things with numbers or what rules can be build to check in management commentary specifically to identify sort of check-list in management commentary.
There are a few ways I've seen EBIT artificially inflated: (1) Recording revenue prematurely before all services are completed or products are shipped (2)
Classifying unrealized investment income or one-time gains as revenue (3) capitalizing normal operating expenses (moving them to balance sheet rather than income statement). Also, sometimes too much cash on the books deflates ROCE. If the management will deploy that cash into good projects in the future or return it to shareholders, then it's also useful to remove cash from capital employed to estimate the ROCE (assuming you trust the mgmt to use the cash wisely in the future)
One interesting past example was Indus Towers - when they had high dues from Vodaphone, their ROCE looked like it was dropping. But now that they've been collecting the dues in the last few quarters (for services delivered many months or years ago) , the ROCE looks artificially higher than it would be for "normal operations".
This is very helpful. Thank you for your insights.