Accounting Ratios

Contingent Liability/Equity (%)

A contingent liability is a potential liability that may occur, depending on the outcome of an uncertain future event. A contingent liability is recorded in the accounting records if the contingency is probable and the amount of the liability can be reasonably estimated.

We penalise companies with high and/or rising contingent liabilities relative to their industry peers. Large contingent liabilities might suggest that a company’s capital commitments will rise significantly and lead to a deteriorating financial position. Around 60% of companies reveal that they have some form of contingent liability; however, these are typically just 11% of equity which is not overly material. We have assumed that certain industries require a higher level of contingent liabilities than others. For example, the food and retail sector’s median average contingent liability is 40-65% of equity, as Figure 63 shows, as opposed to only 4-5% in Pharmaceutical and REITs.

63

Our accounting screen is set to trigger a red flag when contingent liabilities/equity exceed the 80th percentile relative to its GICS industry peers, and/or when there is an abnormally large increase relative to the normal rate of change amongst industry peers over one and three years. This latter red flag is triggered when the increase in contingent liabilities/equity exceeds the 80th percentile relative to the change experienced by GICS industry peers between 2010 and 2015.