Spotting The Next Enron

How Short Sellers Spot The Next Enron

George Anders, Fast Company’s West Coast bureau chief, outlines the following six points from interviews with leading short-selling strategists.

Watch cash flow, not reported net income.

There’s only one way to show strong cash flow from operations: Run the business well.

Take a wary look at acquisition binges.

Some of the most spectacular financial meltdowns of recent years have involved companies that bought too much, too fast.

Be mindful of income-accelerating tricks.

Conservative accounting says that long-term contracts should not be treated as immediate windfalls that shower all of their benefits on today’s financial statements. Those expenses will slowly flow onto your financial statements —and it’s prudent to book the income gradually as well. But in some industries, aggressive practitioners like to put jumbo profits on the books all at once. Such “gain on sale” accounting tricks are a sure sign that the management is being too aggressive for its own good.

Talk to customers.

Do they really use the product? Do they like it? Are they still in business?

Watch stock sales by top company executives.

It’s routine for company executives to say that their stock is undervalued and has a great future. But if they all believe that, then why do some of them hurry to unload shares at today’s prices? Pay extra-close attention to what the chief financial officer does.

See how CEOs handle criticism.

Secure bosses know that not everyone on Wall Street will like their story. They handle critics calmly. CEOs with something to hide are more likely to start shouting when someone challenges their business.

SOURCE: George Anders, “How to Spot the Next Enron,” Fast Company, December 19, 2007. Available at: www.fastcompany.com/magazine/58/ganders.html. Copyright 2007.  Mansueto Ventures, LLC.  Reprinted by permission via Copyright Clearance Center.

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