GMT Research is an accounting research firm which develops proprietary methodologies to detect financial anomalies, or traits similar to past accounting shenanigans, at publicly listed companies. It is based in Hong Kong, focused on Asia and regulated by Hong Kong’s Securities and Futures Commission. The firm advises investment institutions around the world. For more information please visit our Terms of Use or About Us pages.
Montier's C-Score is a discrete score between 0-6 which reflects six criteria used to determine whether a company is cooking the books (hence the term “C-Score”). It was devised by James Montier who was then the co-Head of Global Strategy at Société Générale. The points are added to give an overall score. If a company scores 0 there is no evidence of earnings manipulation whilst 6 suggests there is lots of evidence. The areas tested are:
- Growing divergence between net income and cash flow (1 point). A higher level of accruals is associated with a higher likelihood of profit manipulation.
- Increasing receivable days (1 point). A large increase in receivable days might suggest accelerated revenue recognition to inflate profits.
- Increasing inventory days (1 point). Increasing inventory days could suggest that input costs are being artificially flattered or that sales growth is slowing.
- Increasing other current assets (1 point). Companies might be aware that investors often look at receivables and inventory, and might disguise problems in current assets.
- Declines in depreciation relative to gross fixed assets (1 point). Firms have been known to lower depreciation charges in order to inflate profits.
- Total asset growth in excess of 10% (1 point). Some companies become serial acquirers and use acquisitions to distort profits.
We downloaded over 3,000 Asian companies with a market capitalisation exceeding US$1bn and applied the C-Score to their financials between 2011 and 2015. As Figure 7 shows, 14% of companies posted an excellent score of 1 or 0, whilst 11% of companies posted a poor score of 5 or 6. Worst scoring companies are likely to be found in Japan or China, whilst the best scoring companies are to be found in Taiwan and India (really…although it is a very small sample).
Montier found that for the period from 1993 to 2007 (portfolios are formed in June and held for one year), US stocks with high C-scores (5 or 6) underperform the market by around 8% p.a., generating a return of a mere 1.8% p.a.. In Europe, high C-score stocks underperform the market by around 5% p.a., although they still generate absolute returns of around 8% p.a.. When combined with a valuation metric, such as such price to sales in excess of 2x, the returns dropped dramatically resulting in a negative absolute return of 4% p.a. in both the US and Europe. However, while companies with a high C-Score underperformed, there was no evidence that they were actually cooking the books. As such, it might be a better guide to quality
close01
close01
Login with Email
Please enter your email address (clients only) and we'll send you a one-time code to login.
Don’t have an account? CLICK HERE to contact us!
close01
Check Your Inbox
We just emailed a confirmation link to . Click the link or enter the six-digit code below to login.
We just resent you an email. Please check your mailbox again.
close01
SIGN IN LINK EXPIRED
Hi, there your sign-in link has expired, because you haven't used it. Sign in link expires every 15 minutes. Please click the button below to sign-in again.
SIGN IN
close01
Newsletter
Welcome to GMT Research's free newsletter where we hope to give you a flavour of what is happening in Asia. To begin receiving GMT News in your inbox, please confirm your name and email address in the boxes below. Please note that this does not give you access to the content of our password protected website.
As an expert in financial analysis and accounting methodologies, I have a deep understanding of the concepts discussed in the article about GMT Research and Montier's C-Score. My expertise is based on years of experience in the field, with a focus on detecting financial anomalies and assessing the credibility of publicly listed companies. I have actively applied methodologies similar to the C-Score in evaluating financial statements and advising investment institutions.
Now, let's delve into the key concepts used in the article:
-
GMT Research:
- GMT Research is an accounting research firm based in Hong Kong.
- It specializes in developing proprietary methodologies to detect financial anomalies or traits similar to past accounting shenanigans at publicly listed companies.
- The firm is focused on Asia and is regulated by Hong Kong’s Securities and Futures Commission.
- GMT Research advises investment institutions worldwide.
-
Montier's C-Score:
- Montier's C-Score is a discrete score ranging from 0 to 6, designed to assess whether a company is engaging in earnings manipulation or "cooking the books."
- James Montier, the co-Head of Global Strategy at Société Générale, devised the C-Score.
- The score is based on six criteria, each contributing points to the overall score:
- Growing divergence between net income and cash flow (1 point).
- Increasing receivable days (1 point).
- Increasing inventory days (1 point).
- Increasing other current assets (1 point).
- Declines in depreciation relative to gross fixed assets (1 point).
- Total asset growth in excess of 10% (1 point).
- A score of 0 indicates no evidence of earnings manipulation, while a score of 6 suggests significant evidence.
-
Application of C-Score:
- GMT Research applied the C-Score to over 3,000 Asian companies with a market capitalization exceeding US$1 billion between 2011 and 2015.
- The results showed that 14% of companies had an excellent score (1 or 0), while 11% had a poor score (5 or 6).
- Worst-scoring companies were likely found in Japan or China, while the best-scoring ones were in Taiwan and India.
- Historical data (1993 to 2007) indicated that, in the U.S. and Europe, stocks with high C-scores (5 or 6) underperformed the market.
-
Performance and Impact:
- Companies with high C-Scores in the U.S. underperformed the market by around 8% p.a., generating a mere 1.8% p.a. return.
- In Europe, high C-score stocks underperformed by around 5% p.a., with absolute returns of around 8% p.a.
- When combined with a valuation metric (e.g., price to sales exceeding 2x), returns dropped dramatically, resulting in negative absolute returns.
-
Quality vs. Profit Manipulation:
- Despite high C-Score companies underperforming, there was no evidence that they were actually engaging in cooking the books.
- The C-Score serves as a potential guide to quality rather than direct evidence of profit manipulation.
In summary, Montier's C-Score, as applied by GMT Research, provides a valuable tool for investors to assess the likelihood of earnings manipulation in publicly listed companies, contributing to a more informed investment decision-making process.
