In order to identify red flags for risk management from various financial risk ratios, models, and traditional ratios for Bear Stearns and Lehman Brothers, we list our calculation results below. Based on our calculation, Bear Stearns got 15 red flags, which occupied 68% of total red flags, while Lehman Brothers 12 red flags, occupying 55% of total red flags. These two numbers were high even compared with other investment banks, and companies committed fraudulent activities.
In summary, both Lehman Brothers and Bear had high possibility of going bankruptcy. Compared with Bear Stearns, Lehman Brothers had higher return rate on capital and got relatively better valuation ratios, but it also had higher risk of inflating its revenue and earnings.
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For Bear Stearns, this ratio was -9.7167 in 2007, while for Lehman Brothers, this ratio was 2.5224 in the same year. From numerical perspective, there is a high possibility that both companies manipulated its net income to artificially inflate its earnings to cover up operating problems. In table 9, JP Morgan, Qwest, and Global Crossing had red flag results.
The Quality of Revenues ratio is similar to the Quality of Earnings, except that the emphasis is on cash relative to sales rather than cash relative to net income. Bear Stearns and Lehman Brothers got -0.0635 and 0.7507 respectively, which suggesting these two companies might use some methods to hide its operating performance. In table 9, Enron, Qwest, Global Crossing, and Tyco also had red flags. This tells us that Quality Ratios works efficiently for fraudulent financial reporting companies.
6) Valuation Ratios
Lehman Brothers and Bear Stearns got red flags on all valuation ratios. Many major fraudulent companies had red flags of P/E ratio and many large U.S. banks had red flags of P/S ratio. Low valuation ratios of these two companies indicated that their stock price might not be