The Beneish M-score was designed as a way to detect possible manipulation of a company’s financial statements. The score itself can be anything between –infinity and +infinity, though most scores fall between -10 to 10. Anything below -2.22 is considered a good score and suggests that the company is likely not manipulating their balance sheet. On the flip side, if a company has a score of greater than -2.22 the probability of manipulation increases. That being said, this score doesn’t necessarily prove that a company is manipulating their books. Rather it indicates how probable it is that a company is behaving in a fraudulent manner.
The Beneish M-score is one of the more complex scores to calculate overall – thankfully, the extra work pays off in the end.
When the score was originally created, the numbers you see at the front of each argument were created using a linear regression model based on the odds of bankruptcy surrounding each of these variables.
Creating a screen for the Beneish M-score is simple. All you have to do is import the score and set it to less than -2.22.
As you can see, a good Beneish M-score beats the market. However, it doesn’t necessarily “crush” the market. This is to be expected as this score should be used as a green flag or in conjunction with other parameters before making an investment decision. With 2865 results, there is plenty of room to expand your screener.
Taking a look at the flip side, this screen went through and found all companies that have a Beneish M-score greater than -2.22. These companies are more likely to be committing balance sheet fraud, and as a result may end up being more unstable investments.
The results are exactly as you’d expect. In the past twenty years of data, investing in companies that are likely committing balance sheet fraud doesn’t pan out too well.
This score, like all of the others, is a tool to help you identify strong investment opportunities or eliminate bad apples from the possible investment pool. There are a lot of companies out there asking for your investment and it’s on you to do your due diligence and ensure that you put your money in the right place for your future.
[…] I realized I should begin writing articles on the flags within the score. One such flag, the bad Beneish score, is a key component of the red flags […]