Ever heard of the phrase pump & dump? What about blab & grab? Well, you wouldn’t have lost money on a company like Satyam if you knew the meaning of these terms.
According to Clear Capital, a subsidiary of Noble Group, these are some of the most common methods used by the promoter to drive up the share price of the company. All you have to do is to see if there are patterns in a company’s share price profile where favourable news flow from the promoter is followed by a rise in stock trading volumes, entry of reputed institutional investors, the stock hitting a 12-month high and then the promoter selling his holding. Well, it is almost as predictable like Bollywood flick, right? That is pump & dump for you.
Now, blab & grab: The promoter announces a new venture related to a hot theme, not surprisingly unrelated to the promoter’s company’s core competence. For example, a consumer goods company entering real estate. The objective of the exercise is to raise fresh funds on the pretext of the new venture. Once the funds are raised, the promoter sells the holding which he had acquired in anticipation of a rise in stock prices.
Typically, the new venture then gets postponed due to delays in land acquisition, problems in nailing down the supply chain, difficulty in reaching financial closure with banks, and so on. Following the announcement of the postponement, the share price usually falls sharply.
The next technique is called ‘expense manipulation’, deployed by promoters to pull out cash from the company’s books, especially during bear markets. The most common technique is to suck out cash by inflating ‘other expenses’ or ‘sales and distribution expenses’ or ‘miscellaneous expenses’.
It is also time you realise that accountants are getting creative. According to the Clear Capital report, more than 100 companies in the BSE 500 were resorting to creative accounting to flatter their results. Some of the ‘creative’ tricks used are revenue and cash manipulation. More importantly, the report says that Nifty 50 companies were just as likely as small-mid cap companies to have suspect accounting practices. Now, the real shocker. Guess what the companies did when the Clear Capital approached them to talk about their aggressive financial statements? The companies didn’t even bother to deny any wrongdoing. Instead, they threatened about the reputational damage to Noble if it went public with the information.
Here are some other smoke signals in the report which you can watch out for:
Recording revenue ahead of time: At least 30 companies in the BSE 500 are using aggressive revenue recognition techniques. This is evident from the deterioration in their “cash flows from operating activities” in spite of a rise in EBITDA, suggesting early booking of revenues.
Booking fictitious sales: Around 60 companies in the BSE 500 seem to have booked ‘sales’, which might have arisen from investment income or other income.
Expense manipulation: At least 10 companies in the BSE 500 seem to have shifted expenses away from the current period by significantly reducing depreciation rates.
Cash manipulation: At least 15 companies in the BSE 500 which have disbursed the bulk of their loans and advances to companies in which directors have an interest.
Invisible restatements of prior periods: When summed up the revenues and profits shown in the quarterly results of firms and compared them with the FY08 results, it was found that at least 25 firms in the BSE 500 had profits shown in the full year results, significantly lower than the sum of the quarterly results.