We penalise companies which have short term investments and record significant increases in these investments relative to sales. Companies with short term investments might be using surplus cash to make risky bets and should be investigated further. Another tell-tale sign of companies speculating with their balance sheets would be excessive returns on cash, highlighted in one of our other red flags.
Around 42% of companies globally have some form of short term investments relative to sales, with Korean companies having the highest incidence at 81%, and Australian ones the least at 16%, as shown in Figure 121. We believe this is related to corporate governance issues, as detailed in our report, SPECULATIVE BALANCE SHEETS: Borrowing to Bet (5 Nov 2015).
Our accounting screen is set to trigger a red flag when short term investments are present on the balance sheet, 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 prepaid expense/inventory is in the 80th percentile relative to the change experienced by industry peers between 2010 and 2015.
