Beware these accounting red flags at Reliance Worldwide (ASX:RWC)

Investors want to trust the accounts of the companies they own, but this is not always possible.

What most investors don’t realise is that there are algorithmic ways to check the credibility of company earnings - and one of them is called the Beneish M-Score. We can see it in action by using Reliance Worldwide (ASX:RWC) as an example.

About Reliance Worldwide (ASX:RWC)

Reliance Worldwide is a balanced, mid cap in the Construction Supplies & Fixtures industry.

When it comes to earnings, analysts are currently forecasting that Reliance Worldwide's earnings per share will grow by 65.7% in the current financial year. The group reported a 58% increase in net income to A$65.7m in for the first half of the financial year, so this target looks achievable.

While those figures sound promising, the Beneish M-Score - which I’ll explain shortly - shows that there are areas in Reliance Worldwide's accounts that might be worth closer investigation.

How the Beneish M-Score works

In 1999, a finance professor called Messod Daniel Beneish published a landmark research paper entitled The Detection of Earnings Manipulation. It showed how you can use accounting data to spot problems early.

Since then it’s become an indispensable checklist for professional money managers and investment banks - and you can use it too.

Professor Beneish’s M-Score looks at the year-on-year change in eight different ratios that can be worked out from a company’s financial statements. It looks for these red flags:

• Inflated revenues
• Declining gross margins
• Capitalised and deferred costs
• Excessive sales growth
• Lengthening depreciation periods
• Rising sales expenses
• Increasing leverage
• Higher accruals

Are there accounting risks at Reliance Worldwide?

Here is a graphic that shows how Reliance Worldwide stacks up against the M-Score checklist.

Next Steps

To find more stocks like Reliance Worldwide, you'll need to equip yourself with professional-grade data and screening tools to pinpoint the highest quality companies in the market. This kind of information has traditionally been closely guarded by professional fund managers. But our team of financial analysts have carefully constructed this screen - which gives you everything you need.

In less than a minute, you can be exploring a list of stocks with the very strongest financial ratios in the market. You'll be joining us on a journey towards owning the very best quality stocks possible. So what are you waiting for? Come and get started for free.