Practical analysis for investment professionals
24 August 2014

How to Read between the Lines of Asian Financial Statements

When I was a new analyst following technology stocks for a predominantly US equity fund, one thing I noticed in doing competitor analysis was the low multiples of some Asian companies, even after taking into account the more pronounced differences in accounting systems in those days. Did low-multiple stocks necessarily present good values? Were there any systematic reasons behind the low valuation?

Later I was also given, among other things, the added responsibility of managing a quantitative international equity fund. Finding systematic patterns in company financials that were good indicators of future stock performance became even more challenging.

Still eager to find answers to these questions, I recently read Asian Financial Statement Analysis: Detecting Financial Irregularities and was completely intrigued.

First, this is not your father’s accounting textbook. The authors, ChinHwee Tan, CFA, founding partner of Apollo Global Management in Asia, and Thomas R. Robinson, CFA, managing director of the Americas at CFA Institute, are trained accountants and seasoned analysts, which gives the book a very practical bent. All the examples are actual cases of accounting irregularities identified in Asia. Some are high-profile cases, such as Satyam Computer Services; some are less well-known but not any less revealing.

Second, the authors explain the issues at hand in almost painstaking detail and in a very structured way. As the saying goes, the devil is in the details. This is true for accounting. It is even more so for forensic accounting. For example, rookie analysts tend to lose sight of the relationships between different financial statements (I know because I was one!); they home in on items in the income statements, such as earnings and revenue growth, without paying sufficient attention to balance sheets or cash flow statements. Identifying discrepancies in the trends shown across statements can be very powerful in finding red flags in a company’s financials. The authors discuss in detail the key issues that may point to “red flags” in a company’s financials. Through their disciplined and structured approach, the authors provide investors in Asian securities with a very powerful toolkit.

Third, better governance pays. No one wants poor governance, but investors have often found it challenging to decide on the right trade-off between lapses in corporate governance and, at least seemingly, strong business performance. The book has an entire chapter on corporate governance and related-party issues. In addition to highlighting the common governance issues, the authors provide a few cases in which investors lost substantial amounts because they ignored poor governance practices. There is a feel-good factor to buying companies with good governance practices, but not only that, it also helps investors make more money.

As for answers to my questions, yes, I found quite a few related discussions. On the low valuation of stocks in some Asian markets, the authors find a similar pattern. The differentials between some fast-growing economies’ GDP and stock market performance are striking. One explanation, they suggest, could be the lack of confidence in the markets because of the prevalence of financial scandals. And patterns that analysts/quants can use to build models? There are plenty. I don’t want to ruin your reading pleasure, so I’ll just share one that’s more widely used, namely the cash conversion cycle. If a company’s earnings have been growing rapidly but operating cash flow has not kept up and receivables have become bloated instead, you should at least be concerned about the slowing conversion. It may also warrant a closer look at other warning signals.

You may never have liked accounting. (Neither have I.) But both novice and mature investors in Asian securities could benefit from this exceptionally practical guide to reading between the lines of Asian financial statements. I am keeping this one on my bookshelf. Will you?

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

About the Author(s)
Larry Cao, CFA

Larry Cao, CFA, senior director of industry research, CFA Institute, conducts original research with a focus on the investment industry trends and investment expertise. His current research interests include multi-asset strategies and FinTech (including AI, big data, and blockchain). He has led the development of such popular publications as FinTech 2017: China, Asia and Beyond, FinTech 2018: The Asia Pacific Edition, Multi-Asset Strategies: The Future of Investment Management and AI Pioneers in Investment management. He is also a frequent speaker at industry conferences on these topics. During his time in Boston pursuing graduate studies at Harvard and as a visiting scholar at MIT, he also co-authored a research paper with Nobel laureate Franco Modigliani that was published in the Journal of Economic Literature by American Economic Association. Larry has more than 20 years of experience in the investment industry. Prior to joining CFA Institute, Larry worked at HSBC as senior manager for the Asia Pacific region. He started his career at the People’s Bank of China as a USD fixed-income portfolio manager. He also worked for US asset managers Munder Capital Management, managing US and international equity portfolios, and Morningstar/Ibbotson Associates, managing multi-asset investment programs for a global financial institution clientele. Larry has been interviewed by a wide range of business media, such as Bloomberg, CNN, the Financial Times, South China Morning Post and the Wall Street Journal.

13 thoughts on “How to Read between the Lines of Asian Financial Statements”

  1. Jamal Munshi says:

    Brilliant. Really great article and very useful too. Thank you.

  2. Larry Cao, CFA says:

    Many thanks for your interest and your kind words, Jamal.

  3. Tarun says:

    Thanks for sharing. I will certainly buy this.

  4. richman says:

    Great read, i’l surely check that book out. I am in South Africa, and it could explain some of the differential im facing analyzing small caps here.

  5. Rajeev Kumar Thakur says:

    Superb book. Must read for every investor.

  6. Shari says:

    Thanks for sharing .

  7. Subhankar says:

    Thanks for the review. You’ve raised an important issue by highlighting the cash conversion cycle. If more small investors learn how to read and analyse the cash flow statement first – before looking at the income statement – their portfolios may have more winners than losers.

  8. Norvin Villa says:

    A must read indeed!

  9. Larry Cao, CFA says:

    Thanks all for your kind words. Happy reading!


  10. shiv desai says:

    I think the main reason for discount in valuation for Asian companies (or for that matter any emerging markets’ companies) is the quality of financial reporting they provide. Companies of China, Taiwan, Thailand, India etc; do not provide enough information in the way of MD&A in financial reports, which leaves the information gap.

  11. Jyoti Ranjan says:

    Nice…. Thanks very much. In India government do not want to have a stringent financial norms for their political benefit. Even banks in India present a manipulate balance sheet. government use banks to implement those program which gives them political benefit

  12. Jing Z says:

    Very glad to see a wonderful resource actually exists. I always look for the international financial world subtle comparison when auditing in APAC. Now this book even provided practical cases. Look forward to reading the book and doing brain twisting.

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