Corporate fraud is widespread, even if we only notice it when it blows up, leading to firings, arrests, or lawsuits.
In fact, fraud costs 3 per cent of enterprise value — and thus stock returns — every year for the average U.S.-listed company, according to recent academic estimates.
A new report from GMI Ratings shows that investors can significantly boost returns simply by looking out for certain red flags.
When GMI eliminated the 25% of companies in the Russel 3000 index that scored the lowest on its fraud detection metrics, portfolio returns rose from 7.6% to 9.8% over a 10 year period, a 29% boost.
Here’s their chart of the difference between the regular index and one with the worst-rated companies subtracted:
These are a few of the red flags that GMI looks for:
- Compensation incentives for CEOs and CFOs that are very high relative to base salary
- Late or frequently amended filings
- Consecutive uninterrupted growth in earnings per share
- Accounts receivable are growing at a different rate of sales
- Low asset turnover, and excessively large intangibles
Read the full report at GMI Ratings.
Business Insider Emails & Alerts
Site highlights each day to your inbox.