Stock Picks – What Columbo could teach you about Stock Picking

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When you first saw him, the 1970’s LAPD Lt. Columbo, looked like a bum that just came off the street. He had a bumbling demeanor, was overly polite and seemed to chomp on the same short cigar on a daily basis. However, beneath all that comical exterior was probably the most dogged investigator on the Los Angeles Police Department. Columbo was often called on to investigate high profile murders that involved the rich and famous. The culprits were often amused by him and just as they thought they were going to get away with murder, Columbo would find a way to trap them or find enough evidence to make them confess.

I’m not aware of Columbo’s equivalent in the share tips, stock picks or forex picks market, but I’m certain private investors could do worse than engage in a bit of forensic accounting.  I’m not suggesting companies are doing anything illegal by engaging in earnings management or aggressive accounting but companies who tend to engage in such practises frequently come unstuck, at least relative to similar companies in the same sectors. 

 

The main thing for investors to watch out for is ‘revenue recognition’.  When large discrepancies appear between revenue recognised and the flows recorded on the cash flow statement, this implies that a company is borrowing sales from the future in order to meet its current revenue targets and this is a big negative factor. 

Statistically, when companies engage in aggressive revenue recognition relative to their own history and in relation to their peers, the odds are high that they are set to underperform. 

Another red flag for stock pickers and share tipsters to watch out for is when a company has written off inventory in one quarter and sold it in the next quarter.  This will obviously show up as a 100% profit margin but even the most amateur stock market tipster could see the flaws in this achievement. 

Other factors include shifts in operating items such as R&D spending and taxes.  Finally, for those looking for a good stock pick or share tip, it is worth examining the number of shares outstanding.  Share buybacks funded from internal cash-flow is a positive signal, whereas those funded by external debt is negative. 

Those involved in generating share tips and stock picks ideas for private investors should revisit their old Account 101 textbooks and buy themselves a rumpled raincoat and a cigar!

As the great man from the LAPD himself would say “Oh, there's just one more thing...”

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