Hello, and welcome to another episode of the Odd Blots podcast. I'm Tracy Allaway and I'm Joe wisntal Joe. I don't know if you've been following what's going on in Hong Kong markets lately, but there is a very very big event coming up. Well it's only a few weeks away now, although I have to say I'm not exactly sure when we're at leasing this episode, but in theory, there is a very big event coming up, so much to choose from.
I feel like, you know, when you say something like, oh, I'm not sure if you're following what's going on in Hong Kong lately, my mind darts to, like, uh ten different things. Yeah, okay, But in the market, there is just one thing I think that everyone is focused on at the moment, and that is the I p O of Ant Group, which is the sort of offshoot of
Jack Ma's Ali Baba. The big thing about this particular I p O is that I think they're aiming for evaluation of something like at least two hundred eighty billion dollars, which would easily make it the biggest I p O ever, and the whole transaction again, it hasn't actually taken place yet, but the whole transaction is so big that we're actually seeing it affect things like demand for Hong Kong dollars.
We've seen liquidity in that market Titan. The demand for ant shares is expected to be so high that they haven't even bothered with Cornerstone investors, which is really unusual for an I p O. We're also seeing brokers in Hong Kong offer retail investors twenty times leverage on the ant shares because they're so certain there's going to be a pop on the first day of trading, and everyone wants to get an allocation of the equity when it
first comes out. So it's a really really big deal, and you can see that there's a lot of excitement around at at the moment. Wow, those are some great stats. And I knew it was a big deal, and I knew it was a big company, but actually you sort of just blew me away with all that stuff. I mean, two quick questions for you. A what does AUNT do? I mean, I know it's like this big finance thing, but I actually have no concept of what the company actually does. And be two billion dollars, I mean that's
got to make it. Whether you know, it's bigger than any US financial institution by a laun shot, right, Yeah, I think that's right. And if you think think back to Saudi Aramco. I mean, there was so much talk about Saudi Aramco when they listed on public markets for the first time. I think we even did one or two episodes about it that ended up being something like twenty eight billion dollars raised, so much smaller than what
we're talking about now. Aunt grew Group. I'm sure I'm not going to describe it right, and I'm sure some people are going to take issue, but it's basically the sort of um I think it's the fintech portion of Ali Baba, including Alley Pay, which is one of the big big payments providers in China along with we Chat.
So if you've ever visited China, you know that cash is almost non existent at this point, and anywhere you go, be it a Starbucks or a street side vendor, you can pay using a digital wallet like ally Pay or wee Chat. So that's one of the reasons people are really excited about it. And of course it's a big fintech giant in a very very large market in one of the few markets that is really growing at the moment,
given China's purported economic strength. But of course when it comes to this type of growth, particularly in China, there's always a question mark over how you're actually measuring that and whether those measurements or those numbers are accurate or not, you know what I mean, absolutely so, So just to step back, just to sort of conceptualize the company, um, Ali Baba is this sort of right e commerce powerhouse, extraordinary company doing all kinds of things, And so I
guess you could sort of imagine it is like say, like Facebook or some of the US megacap internet companies, they have their own like sort of payments apps and payments messaging and stuff like that, and so this would be this is Ali Baba's. It's gigantic, and they're essentially spinning it out into its own publicly traded company that's
worth the insane amount of money. But as you say, you know, with with so many of these UH companies, I mean, they produce financials, but all kinds of um difficulty really gating from the outside like a true like size and scope of the business. Yeah, I guess you could think about it as jen if Amazon also owned Venmo or something like that, and everyone used Venmo to pay for virtually everything in the US. Oh, and also that Amazon had a gigantic money market fund that people
using Venmo could also invest in. That's that's kind of Alley Pay in a nutshell. I'm excited now. Okay, So for today's episode, we're going to do a deep dive onto Chinese internet companies. We're going to get a better sense of how they're actually accounting for the growth that I just described, and I think we're going to get a better idea of whether or not all that excitement over future growth is necessarily justified. And to do that,
we're going to be speaking to Stephen Clapham. He's the founder of Behind the balance Sheet and also runs an investment and research training consultancy. He recently published a very very detailed and expensive report into Chinese internet stocks, looking at them from a forensic accounting perspective. So really the perfect person to discuss all this with. I think, alright, I can't wait. You got me super excited. Okay, all right, Steven, welcome to the show. Thanks so much for coming on. Well,
thank you for having me. So I guess to begin with, I'm curious what piqued your interest in Chinese internet stocks in particular, because there's no shortage of companies that you could be looking at with a forensic accounting background, and you chose to look at these ones in particular. I think you looked at five of the biggest ones. What
sparked your interest? Well, Tracy, you said that this report was expensive, and in fact, I want to disagree articly because I think this report is very cheap and the reason I allude at these is five thousand dollars, right, honestly, Tracy, five thousand dollars is a argon for this report. And
before you laugh, and let me explain why. So the reason that I looked at this I was commissioned to produce this report by a client, and one of my training clients is particularly interested in the Chinese um internet companies and was concerned that they hadn't been able to get to the bottom of the way they were accounting in various aspects when we talked about what those aspects were, so they asked me if I could help, and I said, yeah,
of course, and foolishly I completely underestimated how long it would take to to do the work. And when I tell you that Ali Baba's accounts were a thousand and seventy seven pages long, you can probably understand why it's quite easy to underestimate how long it would take. And so I went back to the clients halfway through the work and I said, look, I'm having a better problems here because it's taken me far, far longer than than
I was anticipating. I knew that it would be complicated, but I didn't quite understand how much work would be involved. And the clients, I know, look, no problem at all. I said, Look, the best way around this is I don't want to do a bad job for you, but equally I don't want to spend a huge amount of time and I'm not getting rewarded for so the best compromises, why don't I just sell the report once you were finished with it and once you've done everything that you
want to do in the in the stocks. And they said that's fine, and so we um, we just put the report up on the website a few weeks ago. There's been quite a bit of interesting we haven't actually started to advertise it yet. Obviously, these are very, very big companies, and they are incredibly complicated, and if you think about a set of accounts, it's over a thousand pages long. The most recent accounts are about half that, but it's still a huge amount of time to go through.
And what we do is we go through word by words, number by number, dissecting every element of it. And if you're the average institutional investor, you just not have time to do this detail work. So that's why five dollars is Actually it's not nearly it's not nearly as much as it sounds, because it's saved people a huge amount of effort and there's a huge amount of effort involved
on our side and producing it. Okay, So setting aside whether five thousand dollars is a fair value or not, stepping back a little background, tell us your sort of general work. You mentioned that this was originally produced for a training client. What do you do for clients when you say training clients? And what was the sort of request that came in that ultimately led to this research? Oh? Sure, so we I mean, our business has got three parts to it. We've got our retail side, so we've got
an online training school for retail investors. So you can go there and you can buy one of our courses which helps you understand how to invest. And then on the institutional side, which two things we do bespoke research for people and we run training courses. So we've got a forensic accounting course which we started in June and we've done I think three hundred people have been through that course in the last two and a bit years.
Obviously fewer people this year because it's a physical in perison course, although we've been doing a little bit of it on on Zoom. And on the bespoke research side, people typically will come to us when they've got a problem, they've got a piece of research that is either too difficult for them to do in house, or too time consuming for them to do in house, or sometimes too
controversial for them to do in has. Often what happens is you own a stock and it goes down, and the analyst that's involved in in looking after that position, we'll do one of two things while they say he or she, while they say, you know what, I think, we think I'm in a mistake. We should just get out, or they'll say I'm right, We've just got to be patient.
And often what happens is the portfolio manager doesn't feel that the analyst is being able to make the decision rationally without emotion, and he doesn't have enough time to do the working staff, so they bring me in as a sort of independent third party without any emotion attached to the holding that can make a rational assessment of where the risk and reward lies at this point after the shares have fallen. And that's what we do. It a little bit of that. And the other thing we
do is we do forensic accounting research. So people will say, you know, I'm thinking of I'm thinking of buying a stock and can you please have a look at it? Or they'll say we own this stock, can you please have look at it? In fact, it won't be a surprise to you, Tracy sitting in Hong Kong that Hong Kong listed or Chinese based companies are quite a popular area for people to ask us to get involved. One
we did quite recently it was Hutchinson, so a client. Again, I mean I do this obviously exclusively for Trump for clients that our clients on the training side. I don't get random people coming in off the street asked me to do fends and accounting reports for them. I do it for the people that know me and like my work. And this particular client, very big two billion asset manager. We're interested in Hutchson because it looked very cheap, and he said, can you go and have a deeper dive
and tell us if it really is cheaper not? And that's typically what we do, and this is exactly what we did in the case of the fire Chinese internet companies Ali Baba, ten Cent, JD, dot Com, Buy Do and made To and Ding Dan King. There are those five stocks we were asked to look at and to look at on a series of I think it was a dozen different elements, and there were things like is the company flattering at sarnings? Is the company using investment
gains to boost tarnings? Is it carrying the value of enlisted investments? Are they being carried at the correct values? So it's a whole string of things that we were that we were asked to the camp. That's a really helpful description of what you do. I'm curious when it comes to Chinese stocks though, are there particular challenges that investors face when it comes to things like transparency or
you know, realistic accounts. I guess this is a criticism that we hear about Chinese accounting and Chinese companies quite a lot. There's all sorts of issues you face. I mean, clearly, the first problem you've got is that the first of all I've got is that I don't speak the language. I can't read the language. So you're at a massive disadvantage relative to looking at a company in the United States.
Are in the UK, where you've got that sort of home country advantage and where you've got local pools of knowledge, local sources of intelligence. And we've got some contacts in China. But for example, one of the things that the client asked us to look into was the role of the audit firm and any connections between the partner involved in the audit and the companies. And you know, we had to say to them, look, we can't really do that
because we just don't have sufficient knowledge. We don't have any feet on the ground in China um to be able to assess if there are any hidden links between the company and the auditor, whereas in the UK, for example, that would be it wouldn't be easy to do. But we've got various tools and techniques that we deploy in order to make an assessment if that there, if there could be that sort of connection. But it would be impossible for us to look at something like that in China,
and we don't we just so we don't. We don't, We don't even try. But there's there's a number of issues with Chinese companies in general. Obviously the use of these variable interest entities is a very common that these companies are said, uh and these you know, that has a whole set of other issues which we which we don't go into detail in this report because they're generic. You know, that's a generic thing. What are you buying
when you buy one of these businesses? And you know, there's lots been been written about that, and people I think have made their own judgments about whether they find that an acceptable risk or an unacceptable risk. Instead, what we did here was we drilled down into some of
the specifics. And many of the specifics are related to the nature of these businesses, the fact that they are internet businesses and that they're heavily involved in a whole investment ecosystem, and so a lot of our work was dedicated to that area that part of them. So to do some compare and contrast. Obviously, we have our internet
giants here in the US, Facebook, Amazon, etcetera. Talk to us about some of the general differences that are required for someone to do serious accounting analysis of the books or of the statements of US based Internet companies first Chinese ones. Well, I mean some of these companies report
under US GAP. So there's you know that counting rules are the same, um right, ten Cent reports sunder I f r S, which I think is quite unusual because ordinarily companies that are listed in the US generally have gaps as their main language, mean accounting language, but that counting rules are exactly the same. But what you've got here is if you if you think of Ali Baba and Amazon, they're being they're they're kind of similar in
in concept. I mean they're obviously they do different things and their different score ten Cent, gd dot com you would think of those in the same light as thinking of an Amazon. But if I told you that the Ali Baba cants went from over a thousand pages to just under five hundred pages, do you know how long that counts are for Amazon? Do you want to make
a guess? A good guess? So you're You're obviously practiced at this game, because the Amazon accounts in twenty nineteen, including Jeff Bezos's letter at the front, which is an addendum to the actual pen K filing, was only eighty seven pages, so their cants are much much simpler there and an Amazon um I think, although I disagree with some of it's some of the way it presents its numbers.
You know, I wrote a blog a little while ago about the fact that it presents its free cash flow in three different ways, all of them wrong in my view. I've got a different definition, but at least it is quite helpful in the way it presents its numbers. Some of these Chinese companies are I would open it they're less helpful than ANALYSM. Sorry, can you just dive into
that point? So how are the numbers less helpful? And I'm aware that, you know, one of the criticisms of tech companies all over the world is flattering their growth figures, you know, how many users they have on their platform. There's also, I guess, the use of non gap metrics, the most famous being uh we work and community adjusted EBITDA. Is that the kind of thing that you're that you found in your report. Yeah, absolutely, I mean the use of non gap. I mean this isn't a criticism solely
of these and Neese companies. I mean it's that it's very prevalent throughout Less and Pole hundred as well. Um. But you know these companies, the non gap numbers and the gap numbers are there often miles apart, not so much in the case of ten cents, but in the case of all there for they're very significant differences. And you know one of the main differences, which isn't a criticism of the Chinese companies, more a criticism of the way the South Side community treats the reporting these days.
But they all make huge adjustments for stock based compensation. So I think in the case of Ali Baba, but I remember correctly, it was something like five billion dollars um and that obviously stock based compensation is a real expense because if you didn't give people stock, you'd have to pay them real money. And it's a real expense because it comes at the expense of shareholders, shield shareholders lucid to the extent that these shares are issued. So
it's daft. I think that analysts ignore this number when they're calculating earnings because if they weren't, it wasn't stock based, it'd be cash and they wouldn't ignore it. So I think this is just you know, one aspect. But the one of the big elements in the Chinese group which is different from the US peers is the use of investment gains to flatter profits. Do you see a lot of gains on either the sale of investments or on
the revaluation of investments. And this isn't to say that these companies are doing anything wrong because the counting rules I think are slightly daft in in in this in this respect, because what happens here is that I've got an investment in company X. Company X is a young, fast growing Chinese internet company. It's hungry for capital, so it needs more capital, and it decides to bring in
an outside shareholder. When outside shareholder makes an investment, it's likely to be at a higher price than the price which I have invested, And accounting rules require you to revalue the investment and book the game through the p now, which it's obviously ludicrous. I mean, whoever thought up this accounting standard, I don't know what planet they were that they were wrong but I think it's a I think it's a silly system. And I'm not saying that the
companies are doing anything wrong by adopting this. This is what they're required to do, but it gives a misleading representation of their profitability. So this should be a balance sheet item as opposed to something that would flow down to the bottom line basically, if we're trying to get a true understanding of the company. Yeah, well, I mean I would argue that it shouldn't even be adopted in
the balance sheet. You might want to note what the what most recent valuation was, because obviously it's helpful for investors. But to give you an example, in the case of Ali Baba mean Ali Baba and had an investment in a business and the investment was being reorganized and these are almost invariably very complicated structuring. So this particular investment was an investment that they held jointly without financial and the business was restructured by being merged with another business.
And who should come in to make an investment in it? But soft Bank. Now we all know that soft Bank is not the most disciplined purchaser of assets, and that they've been prepared to invest on the basis of a longer term vision than most other more ordinary shareholders would be prepared to say so, being prepared to pay very high prices for some assets that I think are quite questionable. So Ali Baba also owns it is also partly owned by soft Bank, So soft Bank owns a big steak
in Ali Baba. So what you have is SoftBank coming in paying a very high price for one of Alabama's assets, and Ali Baba then revaluing the value of that asset in its books and taking a difference to profit loss account.
What could go wrong? Well, um, just on that note, could you maybe talk a little bit more about related party transactions because this is something that also crops up quite a bit with Chinese companies, where you often have this sort of shadowy network of companies that are tangentially related to each other and are sometimes, if not self dealing, lending each other helping hand when it comes to things
like funding. What examples of that did you find? There are a lot of related party transactions in in in these companies. Ali Baba is actually not the not the main culprit here. I think it was g D dot Com had the largest exposure it's related party transactions and the problem with the lated party transactions, and that we we cover this in our forensic accounting course for our
institutional clients. We also cover it in online courses for retail investors to say, look, one of the first things that we look at when we open this out of accounts, we look at the related parties, not because if there are a string of related party transactions, you then have to ask yourself, well, who's who's verifying this? How do we know that these numbers are accurate? How do we
know that we're not being disadvantaged? And it's almost impossible for the outside investor to make a rational judgment of this, and equally, it's probably pretty difficult for the auditor to make a real assessment of have the related party transaction has been booked correctly in their cants? And so many of the frauds that I studied when I was originally building the forensic accounting course, I went to spent time in the British Library and I poured through all sorts
of academic studies. I poured through lots of accounts. I looked back at past frauds, and many of them. One of the one of the key signals in advance was related party transactions. And where you've got related party transaction, you just don't know what the motivation is and you don't know whether you are being fairly treated, and that's
a huge it's always a huge risk. So what I say to the to my retail clients is that if you open their hands and there's a page related party transactions, it's probably it's probably not worthwhile pursuing that as a potential investment because it could take you a huge amount of time to verify, and even then you may not know that you've got the right answer. So what else is in there? I mean, you mentioned that the ali Baba accounts are five hundred pages, the Amazon accounts are
eighty seven pages. What else is found in that four hundred and thirteen page gap that fundamentally makes the analysis of an Ali Baba more complicated and more work than the analysis of Amazon. But I mean, it's just this year's scale volume, number of transactions that they're doing, apart
from anything else. You know, when we when we look at companies that are doing a lot of acquisitions and disposals, it's very difficult to determine what's actually going on, because where you've got a lot of acquisitions, and even where you've got disposals, the underlying cash flows can be obscured. Just they explain what I mean using perhaps a simpler example would be you know, you often see rolloups platform
companies where they're making acquisition after acquisition. One of the things that we worry about when we see these is when you look at the operating cash flow in any year, you don't know how much of the cash flow has been generated from the business itself and how much of the cash flow has been generated from improving, for example, the working capital in the businesses you acquired last year.
And you often see this in rollouts where they'll do a lot of acquisitions of of mom and pop businesses. They buy the mom and pop businesses which maybe didn't have an independent credit controller, and they'll enforce very strict terms and their customers, and immediately they get a cash return in that they're working capital shrinks, so they're operating cash flow looks much better than it really would would
do were it not continuing to make acquisitions. And that's fine as long as you carry on making more and more acquisitions and and repeating the formula, But as soon as you stop, what often happens with these businesses is the cash flow on wines and it's the exact same thing is true, but on a different scale for these Chinese companies because they're making loads and laws of acquisitions and disposals each year, and so trying to divorce what's going on in their core business with what's going on
as a result of acquisitions is extremely difficult. Now, they would probably argue that they're investing in young, immature businesses, and to the extent that they're making acquisitions, they're probably having to invest in the working capital, so that the actual cash flows are worse than they would otherwise be. But you're seeing um also a change in the coversation of the businesses. So more of these businesses are going to subscription type models in which customers are paying in advance.
So obviously the opposite is true, and their cash flows would then be enhanced relative to what they would have been if they hadn't been making acquisitions. So the most complicated part of this is the fact that there's lots and lots of moving parts and they're all moving very quickly, and that's what makes the makes the job of understanding
the business much much more complicated. So your description of add backs just reminded me very much of Valiance roll up strategy back in the day, and I remember one of the issues with the roller was that you ended up getting a lot of add backs where the company would add back line items for acquisitions. So, for instance, if it expected a transformational m and a deal to really add to its bottom line, it would add back
extra revenue or extra profit into its accounts. Is that something that you see with Chinese companies and does that also impact they're funding because again going back to the Valiant example, I remember that the ad backs basically made Valiant appear a lot less leverage than it otherwise would have appeared, which allowed it to tap the debt market relatively cheaply for a very long time and keep buying
extra companies. Yeah. I mean Valiant is a very curious example because there was such a massive difference between the numbers that analysts were focusing on and the numbers which were being report that you would have imagined that people would have spent more time focusing on that. I think
the case of these Chinese companies is slightly different. If I told you that if you looked at the last five years for these five companies, um and I told you that they had made investments in the Chinese, predominantly Chinese, and they made a very small number of acquisitions, very small volume of acquisitions overseas. But they basically they've invested in a huge range of Chinese venture capital. And if I told you that they had spent nearly three trillion,
that's trillion, remember in the last five years. So what's that that's like five vision funds, these five companies in five years. I like, how we measure everything in vision funds nowadays? Yeah, it's a great it's a great unit of I think it's a useful it's a useful unity. It's absolutely great. You want to look at you want to scale something ridiculous, And that's so you know, on average, there's a vision fund every year, or a vision fund every company to any how you look at it. But
that's basically what we're saying. And you then have to decide, okay, unlike perhaps the vision fund, have they made sensible investments and that the issue here then becomes, okay, well, what is the carrying value that they're that they're showing in their in their books for these investments, and to be fair to them, they vary. The disclosures do vary from
company to companies. Some are better, some are worse. But you know, there are so there are enough disclosures at some of the companies that you can do some quite detailed analysis and you can come up within assessments that whether you think the numbers are sensible, and that's and that's what we've done. A little spoiler for you. They're
not all sensible. So there are some you know, there's some numbers in there that if we were the finance director we would be rather uncomfortable about the carrying values of those businesses. But the real point here isn't that you know, I can sit here in London trying to value an investment in an unimportant, unlisted, no public information Chinese venture. I mean, obviously that's extremely difficult and would be impossible for me to do, to do the whole thing.
But the question I've got is how can the auditors do that? Because it's not easy, right, and I mean just the scale of these investments is phenomenal. So what you would have to ask yourself is how likely is it that the auditors would have found all the right bands that were required and made the companies take those
right nows. And I can tell you that there right there are There have been right gunds, not saying that haven't there's never been any right downds, but the right bunds are on a somewhat lower scale than division funds. So what does that tell you, Well, it tells you either that they're phenomenally successful at making these investments or that they can justify carrying values because they found somebody
else to come in at a higher price. Which that doesn't mean to say that the values are accurately disclosed in the balance sheet, but it does mean to say that they've conformed with their counting rules right. Or it could be that they've invested a lot of money and obviously the value valuations of these stocks has gone through the roof in the last few years, and they've carried
on investing throughout. So is it possible that these companies will be forced to take some significant right hands in the next few years if the valuations don't hold firm and they've invested in a range of I mean, you know, a very wide range of products. It's not like they're can, you know, confined to a single vertical. They're all trying to expand across a whole range of different activities, many
of them completely divorced from their core business. So we started this conversation talking a little bit about ant Financial and the upcoming I p O valuation target is something like two billion dollars. If someone is buying a share of ant Financial, what do you think they're buying exactly? And Financial wasn't one of the stocks that we were asked to look at because when we were asked to do this work, the filings weren't available, and you know, perhaps the client will ask us to come back and
and have another look at at that one. The difficulty with these sorts of flotations, and you know, it's particularly true in emerging markets, and I've seen a number of times in Asia, is that when there's a buzz, and particularly when there's a large retail component to the deal, the institutions will just follow in because it be that not too so these things. You can create your own success by producing a big enough buzz about the story and then as long as the numbers appear to be
going in the right direction, everything everything is fine. It's only if things stop and you find that they've been sold for more than their otherwise worth. I always think with with I p O s, I used to specialize one of my specialties when I was at the hedge funds. One of the things that I used to do is I used to look for I p o s that
were either really unpopular. So a company coming to the market which was deemed unattractive for whatever reason, needed to come to the market, needed to raise the capital, would often come at a ridiculously cheap price. And on the other side, what we used to do was we used to look for these overhyped stocks coming to the market and we used to shore them. And it was an incredibly profitable strategy because the issue with an I p
O is that you've got very level playing field. Very very few people in the stock market have got history with the company, so everybody's equal, and if you spend more time than your competitors and understand the company better, there's It's one of the few areas in the stock market where you can deploy an information advantage legally. You know, sometimes there's an information advantage, but you've got inside information.
Obviously you can't deploy that. But this is one of the few areas where a fund with a bigger research department with more resources can effectively deploy these resources to gain an information advantage. Actually, I have a sort of curveball question. Here's something I've wondered about, but you mentioned earlier on that. You know, you give advice to people that if they see a whole page of related party transactions and a filing, that's probably a red flag to
steer clear. Are there any you know, when you when people think about forensic accounting, they think about uncovering a good short or maybe sort of justifying long position. Have you done or a people doing any work on sort of quantitative uses of this stuff? So for example, just you know, short all the companies with lots of related party transactions go along all of the parties all of the companies that don't have them to some sort of
market neutral strategy. Are there any sort of approaches to investing in the work that you do that don't try to drill down in one company, but just take a few accounting rules and then do a big balance diversified portfolio based on these items. Yeah, I mean, I think it's a very good question, Joe, and I think that actually most of the popular tools have been all gold
out of existence. So there's a very good paper by research affiliates looking at gross profitability, which was a subject of an academic paper in came up with some very very good results. The fact is that all the algorithms have been using the findings of that paper. And what's happened is those stocks have been re rated, um, and they've done well, but they've done well because they've been rerated.
And I think most of these most of these issues are most of the accounting issues have been arbitraged away. And in fact, in my book which comes out next month, UM, we talk about the fact that algorithms have been kind of the enemy of the the analysts because algorithms can do all this stuff much better than the analyst. And the one area which I'm I'm quite intrigued about but
slightly helpless about is is natural language processing. So we've on some basic textual analysis in this report, looking at the words and trying to interpret whether there has been an unusual amount of obfuscation but by these companies relative to an Amazon, for example. And you can't do this without a computer and there's all sorts of things areas in the in the area of understanding text, understanding words
that computers can do much better. To my knowledge, there isn't anybody that can analyze dissect a computer that can analyze and dissect the related parties notes, because obviously they're very complicated, very specific, and I think that's one of the area's what you do need a human being. Fortunately, it's still some areas what you do need humans, just
on the subject of natural language text. Looking at Chinese accounts, one of the surprising things, or one of the things that I think is surprising to people who aren't familiar with this particular market, is sometimes you read the accounts and you get a lot of mentions of what the company is doing to benefit China or to benefit the
Communist Party and president she and things like that. I remember one of the I guess the most amusing examples that I found it that recently was there was I think it was a bank and someone, probably an old lady in China, had microwaved her bank notes in order to get rid of the virus um on them. She thought COVID might be transmitted through banknotes, and she brought these destroyed banknotes into the bank and they had helped her piece them back together or salvage them in some way.
And the bank had written a footnote in its accounts about this particular incident, and it went into a lot of detail just to say that it was doing its part to help people during the coronavirus outbreak. So that's a long winded way of me asking you how much does politics enter into Chinese accounting corporate accounting? Well, and for these companies, I think their main they're looking westward. Really,
they're looking at the investors in all right. Maybe it's not so true today, but going back a few months, they were looking at Western investment. And I think, you know, talking too much about how they're engineering themselves to help the Chinese government doesn't endear them to the average marginal investor in New York. So I don't think there was as much of that as you might see in a
domestic Chinese issuer. But there's some interesting I mean, some of them have got some quite interesting observations about what they're doing to help the Chinese consumer, what they're doing to help their employees, and and and those sorts of sorts of things. I don't think we saw too many, too much discussion about microwave banknotes or anything along those lines.
I don't I don't recall recall one of those. One last question for you, Stephen, what's your I guess your number one tip to any investor who's trying to survey the accounts of a company that they're considering putting money in, whether it's Chinese or from somewhere else in the world. But I'm glad you I'm glad you asked asked me that. And if I can just put in a plug for my book The Smart Money Method where you got where
you talking about three pillars. So there's three things you should do when you look at a stock to make sure you're not buying a fraud. And you might not be looking to avoid a fraud. You might just be looking to avoid a company that's not going to perform well. And you know all the studies tell you that the majority of stocks do badly, the majority of stocks underperform. So if you do these three simple checks, then you will protect yourself and reduce the odds that you're buying
a loser. The first check is to look at the working capital ratios companies that have rising days of receivables rising days of inventory tend to be well. They can be frauds, but they tend not to be as good investment. And the reason is very simple. If your customers aren't paying you, that probably isn't a good thing. If your stocks are rising, it usually means your customers don't want what you're trying to sell. The second tip is always do a comparison of the margins today with the past
and with the peer group. Every single fraud I studied for my freensic handing course had margins which were higher than peers and usually unexplainable. And the third thing is don't just look at the earnings, look at the cash flow. Is the company generating as much cash as it's reporting in earnings, And if there is a trend in which earnings have carried on going up and cash hasn't, that's
usually assigned to stay away. So those three simple tricks working capital, margin comparisons and cash persus earnings will keep you out of trouble. That was really great. Thank you so much for coming on our boots of great conversation. Oh thank you so much for having me. I mean, I'm absolutely you want to do. That was fantastic. I'm really excited about reading the book now. Thank you so much,
ye Joe. I really enjoyed that conversation. I think it was a useful bit of critical analysis to offset some of the optimism and excitement that we've seen lately, not just around the AT I p O, but around tech stocks really all over the world. I feel like we could just do episode after episode with UM with accountants and particularly forensic accounts. It's just like it's always so interesting and every time we do or like we got
to do more accounting episodes and then we forget. But I always remember after these conversations, like why they're like so interesting and uh, he was like a great sort of articulator of some of the issues that make corporate analysis so difficult and interesting. Yeah, I can't even imagine going through a thousand pages of accounts, but I thought the point about, for instance, related party transactions was a
really good one. If there are pages and pages of complex footnotes and related party transactions, then that's probably a red flag right there, or at least I don't know. I kind of I wonder how many investors are actually going through all of those I can't imagine it's many. You know, it's interesting. I thought your question was really great at the end about politics and the connection between the corporate leadership, particularly these big Chinese companies, and the
government in China. Just in general, it feels like that is such a sort of factor in understanding both like
how the economy works and how specific businesses work. I was thinking back to our our conversation with Tom Rlick, the Bloomberg economist who has the book about the China bubble and so much so many misconceptions of analyzing China, at least in or leaks view, sort of stemmed from the idea that Chinese, the Chinese government by control of the banks, can sort of get any outcome at wants, and it can forestall a bubble or constall bubbles from crashing as long as it wants, And so thinking about
like some of these sort of the non financial companies and the investments they make, and how they mark their investments and whether they get whether they have a um, whether they can find an entity to invest in an investment that will continue to increase the value, it just seems like it's got to be pretty tough to analyze that from any sort of like outside sort of like typical Western standards, when you have so much of the
large industrial leadership of a country so tightened with the government. Yeah, I think that's absolutely right, and that's probably why Chinese political analysis is probably a growing area of opportunity in finance. I mean it is one of the benefits of a command economy, right, you can direct capital and control industries to some degree. And there are examples in China of companies that have basically based their entire business model on
figuring out what it is the Chinese leadership wants. So the best example of that is China Evergrand, which I don't even know how to describe it. It's a Chinese property company, but it also makes electric cars because the Chinese government was really into that, and it also runs some hospitals because healthcare is important. At one point, it got into soccer teams or football because she was really
into sports. It's a it's a that's probably the most extreme example of companies trying to tow the party line, but it's one of the most interesting. Let's do a ever Grand episode. Yeah, you know what I love, like, Hey, we should do an ever Grand episode. But also I love how many times I feel like when it comes to a Chinese, big Chinese company, like there's a really big challenge with how to describe it, right, It's always like, Okay,
it's good. There's it's almost like there's no analog that we can think of, at least among Western companies, for the sort of the range of business lines that some of these you know, Chinese giants are in. Yeah. I always find myself reaching for American parallels and then saying like Amazon but much bigger, or like Apple but much bigger, or like Google but also with a random money market
fund and things like that. I love it. Well. One other things, Um, we gotta start using vision fund as a unit of Yeah, the U s economy by too soft bank vision funds this year. Yeah? Perfect, All right, should we leave it there? Let's leave it there. Okay. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe Why Isn't All? You could follow me on Twitter at the Stalwart. Follow our guest
on Twitter. He's Steve Clapham and his handle is at Steve Clapham and follow our producer, Laura Carlson at Laura M. Carlson, followed the Bloomberg head of podcast, Francesco Levie at Francesca Today and check out all of our podcasts under the handle add podcast and check out Steven's new book, The Smart Money Method. Thanks for listening to to