Lee Kaplan, CFA, CPA, is an equity analyst at Kestrel Investment Management Corporation, an institutional small cap value manager located in the San Francisco Bay Area which benchmarks to the Russell 2000 value index. He is an industry generalist who focuses on public companies in the $150 million to $4 billion market cap range and Audit Analytics is an important tool in his research workflow. Kaplan’s duties include screening, idea generation, and portfolio monitoring and Audit Analytics helps Lee make the most of the available time. “As a boutique firm with a small research team, we lean heavily on technology and Audit Analytics increases my efficiency.”
“Audit Analytics goes through every SEC filing I consider relevant to accounting. It would take me a ridiculous amount of time sifting through a dozen or more individual filings to get the same information. I doubt I could do a better job if I did it by hand and I am saying that as a CPA. As value investors, we take calculated risks on unpopular names. If anything about their accounting and reporting is suspect, I need to know it. Audit Analytics aggregates pretty much everything I need and formats it so it is easy to understand.
Evaluating New Ideas with Audit Analytics
The Russell 2000 value index has around 1,400 members and one to two hundred enter and exit the index annually. Kestrel’s research universe consists of many unfamiliar companies that require substantial research. “…odds are that I’ve never heard of [a given] company and I know nothing about it. So, one of the first things that I do is pull it up in Audit Analytics. Before I spend a lot of time figuring out what they do, what drives earnings and cash flows, their business strategy, etc., I want to know if I can rely on the quantitative information in their filings. In one screen I can see, who audits them and their history of auditor changes, how many CFOs/chief accounting officers they have had in the last decade, whether they have had restatements, impairments or changes in accounting estimates, material weaknesses, etc. A few years ago, the SEC started publicly disclosing their comment letters and the company’s responses. Audit Analytics summarizes and categorizes the comments. There are other products that have management changes but nobody else provides insights into the reliability of the information in filings like Audit Analytics.”
Kaplan uses Audit Analytics to assess risk for Kestrel’s potential investments. “Audit Analytics helps us quantify two types of downside risk. First there is fundamental risk; I thought the fundamentals (earnings, cash flows, assets, etc.) were at x but find out later that they were really at 90%, 75%, 50%…of x. We look at the fundamentals from a factor standpoint, what factors are going to cause the fundamentals to increase or decrease. I need to understand if the risk is limited to the direction the fundamentals go or if there is risk in part or the entire base. Second there is governance risk which is when management does something that causes the stock price to decline substantially. Audit Analytics helps me determine very quickly whether management has their house in order and the systems in place to back up the guidance they are providing.”
“We license other investment platforms. Most other investment platforms are all about numbers; displaying historical balances and estimates of future balances and calculating every imaginable ratio\multiple. Other platforms have some of the same information as Audit Analytics, but they are side attractions. Audit Analytics formats the information in holistic way for getting comfortable with the base I will be using for my calculations and company’s governance.”
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