Our latest forensic accounting red flag is from a biotechnology company whose surging stock price brings with it a significant hidden liability.

We pulled this highlight from yesterday’s research of 104 10-K filings, from which our robo-analyst technology collected 12,874 data points. Our analyst team used this data to make 2,194 forensic accounting adjustments with a dollar value of $117 billion. The adjustments were applied as follows:

  • 943 income statement adjustments with a total value of $7 billion
  • 893 balance sheet adjustments with a total value of $54 billion
  • 358 valuation adjustments with a total value of $55 billion

Figure 1: Filing Season Diligence


Sources: New Constructs, LLC and company filings.

We believe this research is necessary to close the gap between the suitability and fiduciary standard of investment advice services.

Today’s Forensic Accounting Needle In A Haystack Is For Biotech Investors

Analyst Cody Fincher found an unusual item yesterday in Cytokinetics’ (CYTK) 10-K.

On page 121, CYTK discloses that it has 5.2 million outstanding employee stock options. Using the Black-Scholes model, we estimate CYTK’s employee stock option liability to be ~$40 million (8% of market cap). When valuing CYTK, investors need to take into account the potential dilutive impact of these outstanding options.

Investors need to be wary of companies with large employee stock option liabilities. When the stock goes up significantly, as CYTK has today, that liability becomes more significant. If the stock drops rapidly, those options can become worthless and make employee retention difficult.

This article originally published here on March 8, 2017.

Disclosure: David Trainer, Cody Fincher, and Sam McBride receive no compensation to write about any specific stock, sector, style, or theme.

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