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[Music] Hello friends, in this video I am going to tell you a secret. This secret we use internally to analyze the governance of companies. I will call this two hacks that I am going to tell you, how you can identify in a simple way which companies have red flags. Right? Recently, the market has had a close eye on governance. Ever since the market came to know about Rajesh Exports. SEBI, in its report, had mentioned many deficiencies in the financials of Rajesh Exports. So after this, I thought that it is a very good time that I share with you two such secrets that our team, in fact, whenever we do analysis, we always take care that we definitely look at these two things from a forensic analysis point of view and from a governance point of view. Right? Welcome to Yuj Investment Academy. Friends, my name is Mandar. Today in this video, we are going to talk about these two important red flag identifiers. Before starting the video, let me tell you that by visiting our website investindia.in, you can subscribe to our products like Stock Meter, Fundometer, and Model Portfolios. If you use the coupon code RED, you will also get a 60% discount. All our analyses on Stockometer, on Model Portfolios are through our 5G framework. In the 5G framework, a very important pillar is Governance, and among the things we analyze within Governance, I am going to share two things with you here in this video. Right? So, forensic analysis, or identifying governance, or drawing some important conclusions by looking at any financial statements, reading annual reports. Right? This is a very, very important part of understanding the governance of a company. Right? Now, the framework we have created for understanding forensic or doing forensic analysis of companies is actually through a very famous book called Financial Shenanigans. It is written by an economist called Howard Schilit. I would really recommend that if you are interested in accounting-related things or how many companies do financial shenanigans, then definitely read this book. Right? In this book, all those areas and motivations are highlighted very well, using which basically many companies manipulate their books and conveniently choose an option which is more beneficial for them. It is not necessarily a book that tells how to fabricate material misstatements or financial statements, but many times there are gray areas in accounting and financial statement presentation which many companies exploit so that they can show things in a better way and convince investors better. So, let's first move on to understanding what is the first hack among these two hacks I was talking about. Right? The first is the Cash Flow to EBITDA ratio. It's a simple ratio. Because what happens is, we need to understand that whenever we look at the financial statements of any company, you look at its profitability, then those are book profits. That is, those are profits brought into the financial statements, which are as per the accounting rules. What is important? Cash flow is important. Because cash flow tells you whether the book profits are actually translating into cash or not. Right? It can be easy to fabricate accounting profits in many ways. But how will you fabricate cash flows? Right? That is the reason why cash flow has such a huge importance in financial analysis and analyzing for investments. So, we have made a very simple parameter for this, which we use in-house to analyze a lot of companies. So, Cash Flow from Operations, Cash Flow from Operations are shown separately. You will find them in the annual report as well. You will find them in any financial statements that the company declares. So, Cash Flow from Operations should be between 80 to 120% of EBITDA. EBITDA is the book profit. Here we take EBITDA minus taxes so that we do an apples-to-apples comparison. Because in Cash Flow from Operations, we eventually deduct the taxes paid by the company. So, we should also deduct taxes from EBITDA so that a comparison can be made at a similar level. So, we check this for the last five or six years. Right? We check it cumulatively. That is, we compare the amount of EBITDA minus taxes added for the last five years, combined for all five years, with Cash Flow from Operations. CFO, Cash Flow from Operations. What is the rationale behind this? The rationale behind this is that we need to see whether book profits are actually converting into cash flows or not. Right? It's a simple ratio. First, let's look at the example of Kalyan Jewellers. Right? Here, in the case of Kalyan Jewellers, for FY25, from FY20 to FY25, you can see six years in this table. Where in the first column we have taken Operating Profit. The operating profit for these six years is this. Uh, then there is Income Tax, which we will subtract. So, Operating Profit minus EBITDA. The figure for this for six cumulative years is what? That is 5487. Right? Now, if we add the summation of CFO for these six years, that is Cash Flow from Operations, how much is that figure? 4757. 4757 / 5487. What is this ratio? This comes out to be 86. 86.7%. What should this ratio be? Between 80% and 120%. So, this company qualifies this criterion. Right? So, this is a simple check to see this. Why are we taking cumulative for many years? Because what happens is, accounting principles are often very different from cash flow principles. So, it is necessary that we take a longer period of time so that any one-offs, any anomalies that occurred in a particular year, can be eliminated. Right? So, this was a simple ratio with which we can analyze this. One caveat here is that often the usage of this ratio depends from company to company and industry to industry. Now, for banking or NBFC companies, this ratio is absolutely useless. Because it is not a cash flow oriented business. Right? It's a leverage business. So, we also need to understand the nature of the business. And if this ratio is deficient or not in this range, then what are the reasons behind it? Understanding this is also very important. Your analysis will not stop there. But it is a very important kind of a red flag identifier. If a company is not coming in this range. Right? Now let us go to the company which is notorious right now. Rajesh Exports. In the case of Rajesh Exports, if we do the same procedure as we did in the case of Kalyan, then this ratio, Cash Flow from Operations as a percentage of Operating Profit, comes out to be just 11.44%. What should this be? It should be between 80 to 120%. So, it is very highly deficient in this ratio. Now let's move on to our second hack. To the second ratio, which is the trend of revenue versus receivables. It's a simple parameter. We will look at the trend of debtor days outstanding or how debtor days outstanding are, and compare it with revenue. So, check for abrupt variations. It's simple. In the last 5 years or in the last 6 years, by what percentage has the company's revenue increased, and by what percentage have receivables, that is debtors, increased. If the percentage increase in receivables or debtors is higher, it means it could be that the company has made many sales that are perhaps not recoverable. Because of which your debtors are increasing. Right? Because they are not recoverable. So, a sudden increase in debtors means this could mean that the company is trying to book revenue aggressively. Because companies know that if we have to impress the stock markets, we have to show good numbers. How do we know that the numbers reported are correct or not? We have to rely on the auditors. Right? But the job of auditors is also not to find fraud. They also have a clear scope of their work. It is possible that some things might have been missed in their regular checks. So, we have invented some hacks with which we can identify things. Again, let's go to our example. In the case of Kalyan Jewellers, if you compare FY20 to FY25, in these 5 years, the company's revenue has increased by 20% every year on average. Right? 20% CAGR, whereas the receivables, right, the debtors, they have only increased by 13%. If this figure is higher than the growth of revenue, then that could be a red flag. Let's look at the case of Rajesh Exports. If we compare FY20 to FY25, the company's revenue has grown by 17% every year on average. But the receivables have degrown by 12%. Right? Now you will say that this is a good thing because their receivables have become almost half of what they were in FY25 and FY20. Right? A decrease is a good thing. But your analysis should never stop here. You should try to estimate what the nature of the business is. If we look at the trend of the company's receivables, you can clearly see here that it has a very, very unpredictable nature of receivables trend. Uh, from FY21 to FY24, their receivables in the business were between 10,000 to 11,000. Suddenly in FY22, they reduced to around 4900 and then again increased slightly to 6442. So, there is an inconsistency in their receivables. This itself is kind of an indicator that this is not normal. Right? So, if we take a similar example of Rajesh Exports, if we compare FY19 with FY2. Right? We have slightly changed the time interval just to test if consistency remains or not. Because the trend of receivables clearly tells us that things are very inconsistent. Because the company's revenue is consistently increasing. So, why is there such a trend in receivables? Right? So, if we compare FY19 with FY2, then the company's revenue has increased by 10%, but their receivables increased by 13%. Right? So, understanding this is very important. These are some of the basic checks. Besides this, we also do many quantitative and qualitative checks from a forensic point of view so that we are assured about the governance point of view, or that the numbers we are relying on so much, right, the numbers the company is reporting, of revenue, of profit, on which we are relying so much, then it is necessary that we do some basic checks. And only after these checks, we take any stock in our 5G analysis and our model portfolios, only after this thorough analysis, where we try to cover maximum parameters from a governance point of view. Right? Now let's come to the final section of our video. We have tried to introduce a new section. The name of this section is Guess the Stock. We talked about governance. So, related to governance, I will tell you four facts about a company. You have to tell me in the comments which company I am talking about. Right? A few days after this video goes live, I will tell the correct answer in the comments. But I am sure that many of you will definitely try to find it. Find out which company this is. Right? So, Guess the Stock. The first fact is that the promoter family of this company is now holding less than 4% stake in the company. Yet, even as their stake was decreasing, they were effectively controlling the company. Right? And the board of this company did not know about a major financial commitment which was made on the company's behalf. They had made a major financial commitment to a bank, about which the board was not even aware. Right? Second fact is, two independent directors resigned in the same month. Right? When this happened, and they also gave the reason for it, which is weak corporate governance and some misappropriation of the company's fixed deposits to repay promoter group loans. You can understand how important and how blatant disregard this is of governance. Right? Third fact is, SEBI alleged that the company funded its own repayment. Right? So, money was routed in cycles through promoter-linked entities and returned as if there were genuine receivables in the business. Right? A whistleblower complained, and that is how it was cracked open. Now, I will tell you the fourth fact. I think this should give you a good idea of which company this is. This was once one of India's most watched media network companies. Right? It was reaching almost 750 million people, 75 crore people. Right? But its stock lost over 40% in a single year when all these things started coming out. And the company's market cap of over 10,000 crore was destroyed. As the governance overhang mounted. A high-profile merger with a global content giant was supposed to happen, that also collapsed. Right? Probably because the company with which it was supposed to merge was not really sure about the governance of this company. Right? So, this was our Guess the Stock. With this, this video ends here. In this video, we have tried to tell you how we use two simple hacks. Besides this, we have many other quantitative and qualitative factors that we use for our internal governance check. I hope you liked the video. If so, please like the video and share it with maximum people, and yes, don't forget to give me the answer to Guess the Stock in the comment section. Stay tuned to our channel for such videos, and again, don't forget to visit our website invest.in. You can subscribe to very good products like Stock Meter, Model Portfolios, and Fundometer on our website. RED, use this coupon code to get a 60% discount. Thank you so much.