How To Spot Fake, Fraud Or Failing Companies From Miles Away!

Learn how to spot such companies from miles away

- Arul Selvan, Karthik Anand Vijay and Udhayaprakash

Creating wealth for the long haul - this is the main purpose of the readers of 'Wealth Insight. However, it is a topsy-turvy journey. Initially, you may assume some companies to be worth considering but later, they may turn out to be swindlers. Often, companies paint a rosy picture of their present position. A big part of this problem has to do with the way accounting policies give leeway to managers. Giving crooked companies a wide 'bandwidth' to implement accounting policies is not ideal.

In his book 'Security Analysis', Benjamin Graham wrote, "Bond selection is primarily a negative art. It is a process of exclusion and rejection rather than of search and acceptance."

Well, we have taken the same approach for stock selection. It is important for investors to know what to own, as well as what to avoid. Hence, in this cover story, you will learn about some warning signs that can keep you away from trouble.

Here is what you will get:

● First, there is an overview of some past accounting frauds.

● Next, there are seven metrics that will help you see through the accounting mist. These metrics are easy to understand and simple to use.

● Finally, you will come across some qualitative tell-tale signs that can help you spot problems.

A word of caution. First, the metrics that we have laid out are not applicable to companies involved in the lending and insurance businesses. Second, don't use these metrics in isolation. Just because a company performs poorly in one or two metrics, it doesn't necessarily mean that it is cooking its books. But yes, if it is failing on many of them, then that should raise your eyebrows! So, here we go.

A crooked history

To help you understand the anatomy of frauds and hence spot the brewing ones, here is a summary of the past frauds that hit India Inc