[Archives] Can Forensic Accounting Help Predict Stock Returns?

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[Archives] Can Forensic Accounting Help Predict Stock Returns?

To Catch A Thief: Can Forensic Accounting Help Predict Stock Returns? via CSInvesting

Messod D. Beneish, Charles M.C. Lee, D. Craig Nichols**

August 15, 2011

Abstract

What Investors Need To Know When Choosing A Private Equity Manager

investor 1652197064It's no secret that this year has been a volatile one for the markets. The S&P 500 is down 18% year to date, while the Nasdaq Composite is off by 27% year to date. Meanwhile, the VIX, a key measure of volatility, is up 49% year to date at 24.72. However, it has spiked as Read More

An earnings manipulation detection model based on forensic accounting principles (Beneish 1999) has substantial out-of-sample ability to predict crosssectional returns. We show that the model correctly identified, ahead of time, 12 of the 17 highest profile fraud cases in the period 1998-2002. Moreover, the probability of manipulation estimated from this model (PROBM) consistently predicts returns over 1993-2007, even after controlling for size, book-to-market, momentum, accruals and the level of open short interest. Separating high PROBM from low PROBM firms within each of these characteristic deciles greatly improves long/short hedge returns. Further analyses show that PROBM
also helps predict future earnings because of its ability to anticipate the persistence of current years’ reported accruals. Overall, our findings offer significant empirical support for the investment approach advocated by forensic accountants.

[Archives] Can Forensic Accounting Help Predict Stock Returns? – Description

In an ideal world, companies’ financial statements always convey a concise, but representatively faithful, portrait of the corporation’s state of financial affairs. Unfortunately, due either to limitations inherent in the language of accounting, or divergent incentives between a firm’s managers and its capital providers, published financial statements often fall short of this ideal. Sometimes one must look deeper into a firm’s financial reports to extract important elements of its true economic conditions.

In recent year