Running Top Forensic Algorithms On 2012-2019 GE Financials
Summary
- On the heels of Harry Markopolos' accusations that GE has engaged in fraud larger than Enron or Worldcom, do forensic algorithms support these allegations?
- Out of curiosity I ran the scores from four top forensic algorithms that check for earnings manipulation, financial irregularities and bankruptcy risks.
- The Piotroski F-score also was included as a robust fundamental algorithm that assesses value conditions.
- Some patterns emerged that may be of significance, especially in the 2016/2017 reporting periods.
- This idea was discussed in more depth with members of my private investing community, Value & Momentum Breakouts. Get started today »
Do Forensic Algorithms Signal Any GE Financial Fraud?
I took a quick look to see if any of the top forensic algorithms commonly used by certified fraud examiners show any unique signals ahead of the accusations released on GE (NYSE:GE). Part of my regular stock analysis and selections include articles of the most positive and negative forensic stocks in the market: Forensic Stock Analysis For August: Do You Own These Stocks?
I also used certain combinations of forensic scores to predict stock price performance like Tesla's (TSLA) recent 40% decline:The 3 Largest Stocks Now Scoring Worse Than Tesla Before Its 40% Decline.
These models are designed to flag certain elements where examiners could look deeper to assess conditions of a company. I would expect some irregularities to show up on the heels of such a strenuous accusation against GE. Certainly other methods and models were brought to bear in the Markopolos' analysis, but curiosity compels me to see what the resulting scores are for General Electric. The full Harry Markopolos, CFA, CFE, report is available on Scribd here.
A key assertion from the Whistleblower Report spans from 2012 through 2018:
"We calculated GE should have taken a reserve hit as early as 2012, and certainly no later than 2015, but they waited until new management came in and booked what little reserve they could afford in late 2017/early 2018, a $15 billion commitment that they had to request a special exemption from the Kansas Insurance Department (KID) to spread over a seven-year period because, plainly put, GE isn’t liquid right now and likely won’t survive long enough to make their last few years of reserve payments anyway."
Forensic Algorithms on GE from 2012 through Q2 2019:
Certainly a $15 billion alteration from 2012 with application to the books in 2017 could be a strong contributor to conditions in the forensic scores above. The activity documented in 2017 seems to be the main contributor to the shift in forensic scores from 2016 to 2017.
Between 2016 and 2017 you can see substantial changes in scores across all the forensic algorithms, even the deep value analysis Piotroski F-score. The Beneish M-score that was previously credited with detecting Enron's irregularities only turned negative (red) in 2017 and has remained in relative low scoring conditions from 2012 through today.
Oddly, the Montier C score was the only indicator to improve in condition in 2017 and more recently in 2019 has turned more adverse than in prior years. This algorithm is intended to detect manipulation in the financial statements.
Most notably the Ohlson O-score that sets a probability for bankruptcy over the next two years jumped from 7% in 2016 to over 54% in 2017. This marked the most significant deterioration across any of the scores and it corresponded to the time in question highlighted in the Whistleblower Report.
Beyond the period of 2016/2017 there's no strong signal of further accounting or bankruptcy changes in scores, while the Altman Z score and the Ohlson O score have remained in adverse warning conditions for at least several years. The GE forensic scores do not look particularly adverse across all the measures and showed some improvement from the 2017 shift.
Markopolos claims there's still more to come and that remains to be seen:
GE’s $15 billion LTC reserve hit was a nasty market surprise and it’s about to get $29 billion worse.
Markopolos contends,
I believe I have a few smoking guns on GE,” Markopolos told Yahoo Finance’s The Final Round, adding that information was held back from the report for law enforcement. ~ Yahoo Finance
As of this point in time there's no strong signal beyond the Altman Z-score and Ohlson O-score that are trending more positively to suggest forensic conditions have become increasingly worse.
We may discover shortly how these figures bear out in the books with more investigators and regulators analyzing the claims.
These models are certainly not foolproof and were designed by academic researchers to improve the chance of detection of irregularities leading to bankruptcy, earnings manipulation, or flag the presence of financial distress.
At the same time, these models are among the best peer-reviewed forensic models in the financial literature and have some significant documented value.
The Beneish model for example has "correctly identified, in advance of public disclosure, a large majority (71%) of the most famous accounting fraud cases that surfaced after the model's estimation period." (Beneish, Lee, & Nichols, 2013, p. 57).
I trust the insight from these different forensic and value algorithms will give you added value to your investment goals and objectives in the days ahead.
JD Henning, PhD, MBA, CFE, CAMS
References
Altman, E. I. (1968). The Prediction of Corporate Bankruptcy: A Discriminant Analysis. The Journal of Finance, 23(1), 193-194. doi:10.1111/j.1540-6261.1968.tb03007.x.
Beneish, M. D. (1999). The Detection of Earnings Manipulation. Financial Analysts Journal, 55(5), 24-36. doi:10.2469/faj.v55.n5.2296.
Beneish, M. D., Lee, C. M. C., and Nichols, D. C. (2013). Earnings Manipulation and Expected Returns. Financial Analysts Journal, 69.2, 57-82.
Ohlson, J. A. (1980). Financial Ratios and the Probabilistic Prediction of Bankruptcy. Journal of Accounting Research, 18(1), 109. doi:10.2307/2490395.
If you are looking for a great community to apply proven financial models with picks ranging from short term breakouts to long term value and forensic selections, please consider joining our 300+ outstanding members at Value & Momentum Breakouts
- Subscribe now and learn many new models and techniques for short and long term trading success.
- Members receive active trading alerts and live stock picks well ahead of published articles.
- Now into our 3rd year, this rapidly growing service has consistently outperformed the S&P 500 every single year!
See what members are saying about V&M Breakouts HERE
This article was written by
Welcome! I am a Finance PhD, MBA, investment adviser, fraud examiner and certified anti-money laundering specialist with more than 30 years trading and investing stocks and other securities. I'm the founder of Value & Momentum Breakouts.
***
I'm JD Henning, the founder of Value & Momentum Breakouts. I've spent decades capturing many of the best ways to consistently beat the markets. I've earned degrees researching markets, and even more importantly, I've spent the time myself as a trader and investor. I am one of those unusual multi-millionaire, PhD's in finance, former Coast Guard officer with a bunch of certifications ranging from anti-money laundering specialist, investment adviser, to fraud examiner... who genuinely enjoys helping others do well in the markets. I'm bringing the fruits of my experience and research to this service. I am highly accessible to members to answer questions and give guidance.
***
It's been quite the start of the year for investors. My guess is, after a decade of good times in the market, you’re here looking for some guidance in how to navigate these volatile markets and the uncertainty of the coronavirus and inflationary conditions. You’re in the right place. For the past 7 years I’ve made my trading systems public and helped thousands of my subscribers navigate and profit from every market downturn and breakout. Please be sure to read the reviews of my service from actual members!
***
Value & Momentum Breakouts doesn't stop with the Momentum Gauges® and the Bull/Bear ETF strategy. The service is designed for investors who appreciate having easy access to quick picks from many top quantitative financial models across different types of investing strategies. Portfolios and selections cover all types of investments:
***
Commodity and Volatility fund trading
Cryptocurrency chart analysis
Long term high-dividend growth stocks
Short term high-frequency breakout stocks
Forensic analysis value stocks
Value enhanced long term growth picks
ETF sector and bull/bear combination trades
Dow mega cap breakout picks
Sector and Index Momentum Gauges® for market timing
***
I share my expertise by generating frequent Value & Momentum Breakout stock portfolios from the different financial algorithms across peer-reviewed financial literature.
***
Try a 2-Week FREE trial and see all the value for yourself.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.