QualityM-Score#48

Earnings Quality

An earnings manipulation detection model that flags companies potentially inflating their profits. An M-Score above -2.22 suggests higher probability of earnings manipulation. The model famously flagged Enron before its collapse.

Formula

-4.84 + 0.92(DSRI) + 0.528(GMI) + 0.404(AQI) + 0.892(SGI) + 0.115(DEPI) - 0.172(SGAI) + 4.679(TATA) - 0.327(LVGI)

Description

Messod Beneish's earnings manipulation detection model, published in 1999. It uses eight financial ratios to flag companies that may be artificially inflating reported profits. The model famously identified Enron as a likely manipulator before its collapse.

Interpretation

Below -2.22: Low manipulation probability. Above -2.22: Higher probability of manipulation, investigate further. Not a guarantee of fraud but a useful screening tool. Pay extra attention when M-Score suddenly spikes from a historically low level.

Related Quality Indicators

Return on Equity (ROE)Op Margin

The percentage of revenue left after paying all operating expenses but before interest and taxes. This shows how efficiently the core business runs. Above 15% is generally strong. Consistently expanding margins signal improving business quality.

Return on Assets (ROA)Net Margin

The percentage of every revenue dollar that becomes bottom-line profit after all expenses. Above 10% is strong for most industries. Persistently high net margins often indicate a company has a competitive moat protecting its business.

Return on Invested Capital (ROIC)EBITDA Margin

Profitability before the effects of debt, taxes, and depreciation. Useful for comparing companies across different tax jurisdictions and capital structures. Above 20% is generally strong. Often used in merger and acquisition analysis.

Return on Capital Employed (ROCE)FCF Margin

The percentage of revenue that converts to free cash flow. This is arguably the most honest profitability metric because free cash flow is difficult to manipulate. Above 10% is strong. Capital-light businesses like software companies tend to have the highest FCF margins.

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