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'Cooking the Books' Score (Montier C-Score)


The 'Cooking the Books' Score gives a visual representation of the likelihood that a firm may be trying to 'pull the wool over investors eyes'. It is based on James Montier's 'C-Score' as defined in his book 'Value Investing'. There are six inputs, each designed to capture a common technique for massaging earnings, scored in a pass/fail fashion to create a score between zero (no sign of manipulation) and six (all flags present!).

Montier backtested the C-Score between 1993 and 2007 discovering that portfolios of stocks which scored 5 or 6 underperformed the market by 8% each year in the US. When combined with a high valuation measure (e.g. Price/Sales > 2) it generated an negative absolute return of 4% per annum.

Vodafone has a C-Score of 1 indicating the company shows very little sign of massaging earnings.

NO
Is there a growing divergence between profit and cashflow?
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In general, managements have less flexibility in shaping cash flows than earnings. Earnings contain a large number of highly subjective estimates such as bad debts, pension returns etc. A growing divergence between net income and cash flows may also indicate more aggressive capitalisation of costs. (James Montier)

YES
Is it taking longer to receive the cash after sales are booked?
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This, of course, signifies that accounts receivable are growing faster than sales. This measure is really aimed at picking up channel stuffing (sending inventory to customers) (James Montier)

NO
Is it taking longer to sell inventories?
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Growing inventory is likely to indicate slowing sales, never a good sign. (James Montier)

NO
Is the proportion of 'other current assets' growing?
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Canny CFOs... may use this catch-all line item to help hide things they don’t want investors to focus upon. (James Montier)

NO
Is the depreciation rate increasing?
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To beat the quarterly earnings target, firms can easily alter the estimate of useful asset life. (James Montier)

NO
Is there a high level of total asset growth?
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Some firms become serial acquirers and use their acquisitions to distort their earnings. High asset growth firms receive a flag in this score. (James Montier)

For further information on how the Montier C-Score is calculated click here.

View our 'short selling' Montier C-Score Screen click here.

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