Beware of the inflection point in Shenzhen Stock Exchange’s investment performance and identify fraud

The protagonist of the story, Company A, was listed on the A-share market in 20X1. The financial performance of Company A after listing is listed as follows:

From the table, we can see that Company A was profitable in 20X1, the initial year of listing. A large loss occurred in 20X2. Company A still suffered losses in the first three quarters of 20X3, but its revenue increased significantly in the fourth quarter, resulting in a small profit for the whole year of 20X3. Thereafter, although it also achieved profitability in 20X4, Company A continued to suffer large losses for two consecutive years in 20X5 and 20X6. In 20X5, Company A also announced the launch of a "She Tun Xiang" acquisition of a company in a related industry. Company A's stock price doubled during the same period.

At first glance, Company A has had profits and losses in recent years, which is a business situation worthy of vigilance. The China Securities Regulatory Commission issued an administrative penalty decision on Company A in 20X6, finally revealing to the public the financial fraud of Company A

What is the truth? Let us analyze this case based on the knowledge introduced in the previous series of articles.

1. Motives for financial fraud

In the fourth quarter of 20X3, it was not difficult for aspiring investors to discover the motives and signals for profit fraud.

First of all, Company A’s performance changed in the second year after it went public, and its losses significantly exceeded the profit of the previous year. If Company A continues to suffer losses in 20X3, it will be subject to a delisting risk warning (hereinafter referred to as "*ST") in 20X3. Surrounded by these objective factors, Company A has a relatively strong incentive to turn losses into profits in 20X3.

Secondly, the pace of Company A’s turnaround from losses to profits is quite abrupt. After continuous losses in the first three quarters from 20X2 to 20X3, it suddenly turned losses into profits in the last four quarters of the year. This in itself is worthy of investment. readers’ attention and thoughts.

2. Methods of financial fraud

After smelling the motive, let us peel off the cocoon and reveal the true face of the fraud.

In order to avoid being issued a delisting risk warning, in this case, Company A adopted two methods to raid profits in the fourth quarter of 20X3:

1. Misrecording of expenses during the period

This fraudulent method is to artificially move expenses to subsequent years, thereby reducing accrued expenses for the current period and achieving the effect of inflated profits.

You can observe whether the ratio of revenue to costs and expenses is reasonable by observing the balance sheet, income statement, income statement supplementary information, employee compensation payable, key management personnel compensation and other report information.

Specifically, Company A’s half-year income and employee compensation data from 20X1 to 20X3 are listed as follows:

In the above figure, Company A’s income in the second half of 20X3 There has been a sharp increase, but employee compensation has gone down in reverse. If investors pay attention to the amount of employee compensation accrued and paid in each year of the company (shown in the notes to the financial statements), and make horizontal comparisons between years combined with sales revenue (visible in the income statement), they may find that the cost is delayed in accounting. Evidence of fraud.

Sure enough, when the notes to the financial statements and the income statement are combined, it can be found that the 20X3 year-end bonus in RMB that Company A will distribute in January 20X4 will be included in the expenses of 20X4. Therefore, the expense accrued in 20X3 is reduced through the mismatch between expense periods.

2. Inflated income

This method of fraud is to increase income through various channels, which can be real transactions or false transactions, such as forging contracts and bills. etc., or inflate income through unreasonable accounting estimates and other means.

In December 20X3, near the end of the year, Company A temporarily attached a marketing policy with "ulterior motives" to the sales of some products, such as "If you are not satisfied before March 31, 20X4, you can Full refund" and other terms. Even if such terms exist, Company A will still recognize all sales amounts under this part of the sales arrangement as sales revenue for the current period, which resulted in Company A recognizing revenue in advance in December 20X3 and ultimately achieving a "turnaround" in the fourth quarter.

Investors can analyze whether the company has any motivation to achieve profitability (such as near the critical value, etc.) by observing the overall profit and loss status of the financial statements, whether the revenue and cost are proportional, and the gross profit margin level, etc. .

In this case, the financial fraud was due to the recognition of abnormal revenue at the end of the year, resulting in large fluctuations in quarterly revenue and profits.

Company A’s quarterly operating income and quarterly net profit data trends from 20X1 to 20X3 are as shown in the figure below:

By horizontally comparing the financial data of previous years and checking quarterly, from the income From a perspective, Company A's quarterly operating income remained relatively stable or changed slightly from the first quarter of 20X1 to the third quarter of 20X3. However, its operating income increased significantly in the fourth quarter of 20X3, accounting for 40% of the annual operating income. From the perspective of net profit, the net profit was negative from the first quarter of 20X2 to the third quarter of 20X3. However, the total net profit increased sharply in the fourth quarter of 20X3, achieving net profit accounting for 500% of the whole year, and making the company Profitable throughout the year.

To sum up, it is not difficult for rational investors to find that in the absence of obvious seasonal fluctuations in business, the "excellent" operating income and net profit performance in the fourth quarter of 20X3 warrants heightened vigilance.

3. "Little secrets" for identifying financial fraud

Secret 1: Be careful when there is a sudden turning point in performance

First, when the invested company suffers a loss for the first time When doing so, you may wish to analyze financial proportions and read relevant public information to find the reasons and trends for losses to determine the rationality of its financial statement performance. Second, when there is a sudden "turning point" in performance, you must carefully verify its commercial rationality, especially paying attention to company announcements and peer industry performance to see if there are any negative signals. Third, unique products of the capital market such as *ST and shell guarantees may induce financial fraud in listed companies. Investors are advised to make cautious decisions.

Tip 2: Be careful when "attracting attention from regulatory authorities"

In 20X4, Company A was investigated by the China Securities Regulatory Commission for improper trading of precious metals and was punished by the regulatory authorities. When the company was in the stage of mergers and acquisitions and transformation in 20X5, its stock price fluctuated significantly, and it also received special attention from regulatory authorities.

Investors who are interested in identifying regulatory risk tips can check the regulatory letters and market dynamics received by the proposed investment company in recent years on the regulatory agency website and major information release platforms.

Shenzhen Stock Exchange’s regulatory information disclosure column: /disclosure/

Juchao Information Network: info.com.cn/

View the regulatory agency’s announcements and Letters are the most direct, authoritative and reliable way to quickly understand the company's recent situation.

Investors should be vigilant when investing in such companies and make appropriate investment decisions based on their own risk tolerance and preferences.