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It is a scoring mechanism developed by us for testing any company on its Accounting Quality (AQ) and Corporate Governance (CG) and making a judgment on the company based on the score obtained by it. The data used by us for this analysis is as per disclosure in company’s annual reports and the scoring is done based on last 5-7 year data for each company (standalone as well as consolidated) across 14 different attributes which have been identified by us. The AQCG score is given in % terms and a company can score between 20% to 100% (worst possible to best possible). These 14 attributes for AQCG scoring are identified after deep thought so as to ensure that they judge the accounting and corporate governance standards of the company fairly. The AQCG score can be calculated for each year for any company (which in turn would be based on previous 5-7 years of AR data). We don’t give scores to companies based on their growth or return ratios in this mechanism and this scoring is largely to judge their integrity and management quality . So, a very fast growing company with high ROE but making no cash flows consistently and having high contingent liabilities and showing other signs of leakages and poor governance would score low in this mechanism.
Companies scoring high on AQCG score have generally been managing their affairs rather nicely over consistently long periods of time and hence would fall in category of good quality companies (in terms of their conduct and financial reporting etc). Companies who score low on this have either been using sharp practices in financial reporting or have dodgy corporate governance (barring few exceptions of course). As a fund house, we would do well to focus on companies having high AQCG score as they are better managed companies with high probability of being run by honest as well as competent management. However, these companies may or may not be best investments at any given point of time as that would depend on the growth prospects and valuations at that time for which the deep dive fundamental analysis would complete the loop.
Attributes considered while calculating AQCG Scores
After considering various attributes, the following 14 attributes were decided upon by us to have maximum relevance with our main objective.
| Sr No. | Attribute | Avg of () Years Data | Brief | Analysis |
|---|---|---|---|---|
| 1 | 3Y OCF/3Y EBITDA | 3 | We divided the sum of 3 years OCF data by sum of 3 years EBITDA data for each year. To make this attribute lenient in nature, while scoring the company we have further taken an average of the past 3 years figures of this attribute. | Higher the better |
| 2 | Depreciation Rate as % of Gross Block (YoY) Chg in bps | 5 | To smoothen the effect on depreciation rate due to changes in IND AS in 2016, we have taken an average of past 5 years | Lower the better |
| 3 | Cash Yield - % | 5 | Interest and dividend income is divided by the average of cash and liquid investments of a company Further, to reduce the possibility of including manipulated date in our calculations, if the cash yield is more than 15% in a specific year, the cash yield for that year will not be taken into consideration while calculating 5 years average figure | Higher the better |
| 4 | Bad Debts w/o as % of EBITDA | 5 | Average of 5 years data of bad debts written off as a % to EBITDA - shows how well a company is able to manage its bad debts | Lower the better |
| 5 | Chg in Debtors to Chg in Sales | 5 | Percentage change in debtors to percentage in sales is calculated for each year, and then average of the past 5 years is taken to derive at this figure. If there is a consistent positive change in debtors which is higher than positive change in sales, the data could be considered to be manipulated | Lower the better |
| 6 | Forex gain/loss as % of EBITDA | 3 | Average of absolute value of forex gain or loss as % to EBITDA of past 3 years is considered. This attribute shows the % exposure of the company to foreign exchange rates | Lower the better |
| 7 | Misc Exp as % to total sales | 3 | Higher miscellaneous expense as compared to total sales shows company's inability to bring in economies of scale | Lower the better |
| 8 | CWIP/Gross Block | 5 | Past 5 years average of capital work in progress divided by average gross block- shows how well the company is able to convert its CWIP in a year | Lower the better |
| 9 | Capex/EBITDA | 5 | Consistently high capex as a percentage to EBITDA could imply that the management is manipulating data by showing expenditure that has not been incurred. We have considered past 5 years while calculating this attribute so as to be able to give benefit of doubt to the company in case of high capex in a few years | Lower the better |
| 10 | Capex as % to OCF | 5 | Similar to the previous attribute, this attribute shows the capital expenditure of a company purely as a percentage to its operating cash flow | Lower the better |
| 11 | Promoters Salary as % of PAT | 3 | If a promoter draws higher percentage salary as compared to PAT, it shows that the management is only interested in making personal gains | Lower the better |
| 12 | Contingent Liability as % of Networth | 5 | Higher contingent liabilities show the possibility of high exposure to liabilities in future | Lower the better |
| 13 | F Score | 3 | Piotroski F score follows a binary scoring mechanism and sums up the scores to derive at final score that ranges from 0 to 9. Following are the 9 factors are considered fo the same- 1. ROA: Return on assets. Net Income divided by year beginning total assets 2. CFO: Operating Cash Flow divided by year beginning total assets 3. ROA: Change in ROA from prior year 4. ACCRUAL: CFO compared to ROA 5. LEVER: Change in Long-term Debt/Average Total Assets ratio 6. LIQUID: Change in current ratio 7. EQ_OFFER: Total common equity between years 8. MARGIN: Change in Gross Margin Ratio 9. TURN: Change in Asset Turnover Ratio (Revenue/Beginning Year Total Assets) | Higher the better |
| 14 | Asset Turnover | 5 | Net sales by total assets - this ratio shows how efficiently a company can use its assets to generate sales | Higher the better |
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