I recently wrote briefly about Intellego Technologies (SSE: INT) and how the company had possibly committed fraud:
“Earlier this week, the company’s CEO was arrested on “suspicion of gross fraud”, and SEK 100 million of its cash reserves were seized by Swedish authorities. The trading of Intellego Technologies’ shares on the Swedish stock market was also suspended.
Although not much is known yet of the apparent misdeeds conducted by the CEO, the “gross fraud” is “related to [Intellego Technolgoies’] press releases and quarterly reports in 2025.””
There is one tell-tale sign that Intellego Technologies’ management was highly likely to have engaged in chicanery: A huge discrepancy between the company’s net income and operating cash flow, as shown in Table 1. This is a well-known flag for possible financial-wrongdoing by a company that is described in forensic accountant Howard Schilit’s book, Financial Shenanigans.
Not every company whose net income and operating cash flow diverges for some time is fraudulent. Netflix* is a great counter example. Table 2 shows the company’s net income and operating cash flow over the past decade. The two financial numbers took very different paths from 2015 to 2019 before eventually converging.
Nonetheless, a good rule of thumb to avoid a company in the stock market that is conducting fraud is to watch its net income and operating cash flow. If a company’s net income looks much better than its operating cash flow for some time, it pays to look beneath the hood.
*There are no certainties in the world of finance, so there is still a very remote possibility that Netflix is a fraud, although the probability decreases with each passing year. In any case, Netflix’s net income and operating cash flow took different paths from 2015 to 2019 because the company was investing heavily in developing its in-house content library, which required cash upfront.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in Netflix. Holdings are subject to change at any time.