Shares of companies with better accounting policies have outperformed the Sensex by a bigger margin than the ones with weaker practices, a study by broking firm Ambit showed. The analysis is based on the consolidated accounts of 337 companies, excluding banks and financial services firms, from the BSE 500 index, in the last five years.
Companies in auto, consumer durables and consumer goods sectors were the best performing, while those in real estate, utilities and infrastructure were the worst-performing, based on certain accounting parameters (as listed in the graphics alongside the story). The accounting quality has rubbed off on their share prices.
"Whilst the share prices of companies across auto, consumer and FMCG have outperformed the Sensex by a large margin over April 2007–November 2012, the share price performance of companies across infrastructure, utilities and realty have either broadly been in line with the market or underperformed the Sensex," said Ambit's analysts, Bhargav Buddhadev and Harshit Vaid, who co-authored the report released on Friday.
|Ratios used to determine the quality of accounting standards |
- CFO/Ebitda: Measures a company's ability to convert Ebitda (which can be relatively easily manipulated) into operating cash flow (which is more difficult to manipulate). A fall in this ratio is negative.
- Miscellaneous expenditure as a percentage of revenues: Checks the company's expenditure policy. A rise in this ratio is negative.
- Asset turnover: Checks on companies that have been incurring capex and increasing their gross block but does not translate into higher revenues. A declining ratio highlights inefficiencies.
- Provision for doubtful debts as a percentage of gross debtors: Checks on company's provisioning. A declining ratio raises concern about earnings being boosted through aggressive provisioning practices.
- Contingent liabilities as a percentage of net worth: Checks on the company's off-balance sheet liabilities. A constant increase raises concerns over the company's balance sheet strength.
- Audit fees: Worrisome, if growth in audit fees exceeds the growth in revenues as audit fees should not generally grow linearly with revenues.
However, companies in infrastructure, agro-related and media sectors have seen an improvement in accounting quality, the study said. Accounting practices of utilities, engineering & construction, capital goods and cement have deteriorated, it said.
"From an investment perspective, it is worth looking at sectors that have seen a positive change in their accounting scores but the same has not yet been reflected in their stock price performance," the Ambit analysts said.
Shares of infrastructure and media companies could spring a surprise' in the future thanks to the improvement in accounting quality, the report said. Shares of consumer durables companies and retailers may disappoint because they have outperformed the Sensex in the last five years.
In conglomerates, companies have faltered in their quality of account practices mainly in two areas: revenue manipulation (CFO/Ebitda is low) and expense manipulation, Ambit said.
|ACCOUNTING QUALITY SCORES VIS-A-VIS SHARE PRICE PERFORMANCE |
| ||Number of |
in the sector
|Average annual % change in accounting |
|Share price |
performance % (April '07-Nov'12)
relative to Sensex
(April '07- Nov'12)
|Sectors with superior accounting quality |
|Autos ||8 ||199 ||1.30 ||15.80 ||9.90 |
|Consumer Durables ||5 ||196 ||2.40 ||43.60 ||37.20 |
|Retail ||9 ||194 ||-1.20 ||36.30 ||30.70 |
|Logistics ||3 ||190 ||-2.60 ||11.10 ||4.70 |
|FMCG ||24 ||190 ||-0.50 ||31.10 ||24.70 |
|Sectors with weaker accounting quality || || |
|Conglomerates ||11 ||138 ||-1.00 ||7.70 ||1.40 |
|Realty ||16 ||142 ||0.50 ||-3.80 ||-8.10 |
|Utilities ||17 ||153 ||-4.90 ||2.60 ||-2.60 |
|Shipping ||5 ||156 ||3.70 ||-13.10 ||-19.40 |
|Textiles ||7 ||158 ||5.40 ||4.30 ||-2.10 |