Ok, here is a short description of the three items.
Probm is short for probablility of manipulation using:
DSRI - Days’ sales in receivables index. Measured as the ratio of days’ sales in receivables in year t to year t-1. Large increases could indicate attempts by management to inflate revenues.
GMI - gross margin index. Measured as the ratio of gross margin in year t-1 to gross margin in year t. Gross margin has deteriorated when the index is above 1. All else being equal, a firm with poor prospects is more likely to engage in manipulation.
AQI - asset quality index. Asset quality is measured as the ratio of noncurrent assets other than plant, prperty and equipment to total assets. AQI measures the proportion of total assets where future benefits are more opaque and the assets are considered intangible. The measure may indicate attempts at cost deferrals in the form of intangible assets on the balance sheet.
SGI - sales growth index. Ratio of sales in year t to sales in year t-1. Sales growth does not indicate manipulation; however, high sales growth does create certain expectations for management - many of which are unsustainable. Managers who face decelerating fundamentals and who currently manage high-expected-growth firms have high incentive to manipulate earnings.
DEPI - depreciation index. Measured as the ratio of the rate of depreciation in year t-1 to the corresponding rate in year t. DEPI greater than 1 indicatres that assets are being depreciated at a slower rate. Managers may be adjusting depreciation methods to temporarily inflate earnings.
SGAI - sales general and administratrive expedcnses index. The ratio of SGA expenses in year t realtive toyear to-1. Firms with growing SGA may indicatre managers who are capturing firm value via higher salaries.
LVGI - leverage index. The ratio of total debt to total assets in year t relative to year t-1. An LVGI greater than 1 indicates an increase in leverage, which may increase the probablility that a firm will breach a debt covenant. All else being equal, the probablility of manipulation is higher in the face of a potential covenant breach.
TATA - total accruals to total assets. Total accruals calculated as the change in working capital accounts other than cash less depreciation. High accruals indicate a higher likelihood of earnings manipulation.
The formula putting these together is
PROBM = -4.84 + 0.92DSRI + 0.528GMI + 0.4404 * AQI + 0.892*SGI + 0.115 * DEPI - 0.172 * SGAI + 4.679 *TATA - 0.327 *LVGI
PMAN then = CDF(PROBM) where CDF is the cumulative densigty function for a normal (0,1) variable. PMAN is the chance of manipulation. A PMAN value of zero implies no chance of manipulation, while a PMAN value of one indicates that manipulation is certain.
STA - Scaled total accruals
This was published by Richard Sloan.
STA - (CA - CL - DEP)/Total Assets
CA - Change in current assets minus change in cash and equivalents
CL - Change in current liabilities minus change in Long term debt included in current liablilities minus change in income taxes payable.
DEP - depreciation and amortization expense
An accrual measure can be expressed as:
STA - (Net Income minus Cash flow from Operations)/Total Assets
SNOA - Scaled net operating assets
SNOA = (Operating Assets minus Operating Liabilities)/Total Assets
OA - total assets minus cash and equivaletns
OL - total assets minus Short term debt minus long term debt minus minuority interest minus preferered stock minus book common equity
For STA and SNOA, low values indicate buys and high values indicate sells.
From the book (not verbatim), Quantitative Value, Wesley Gray, PhD and Tobias Carlisle, LLB.
Are there any approaches from P123 that can address serious problems that the company is hiding?
Bryan