Are the earnings real — and is this business financially sound? Run three institutional-grade tests on any stock: the Beneish M-Score detects earnings manipulation, the Altman Z-Score predicts financial distress, and Buffett's Owner Earnings reveals true cash generation. The Beneish M-Score would have flagged Enron as a likely earnings manipulator — one year before its collapse.
Developed by Professor Messod Beneish in 1999, the M-Score uses eight financial ratios to estimate the probability that a company is manipulating its reported earnings. An M-Score above −1.78 indicates a high probability of manipulation (Red Flag). The model famously would have flagged Enron as a likely manipulator one year before its collapse.
Created by Professor Edward Altman in 1968, the Z-Score combines five financial ratios to predict the likelihood of corporate bankruptcy within two years. A Z-Score below 1.81 places the company in the "distress zone" (Red Flag). A separate formula is used for non-manufacturing companies, omitting the asset turnover variable to avoid sector bias.
Introduced by Warren Buffett in his 1986 Berkshire Hathaway letter, Owner Earnings strips away accounting conventions to reveal how much cash a business truly generates for its owners. When Owner Earnings are significantly less than reported Net Income (OE/NI ratio below 0.5), it's a red flag that reported profits may be overstated by non-cash accruals.