As earnings season gets underway, investors can use a few tools to figure out if companies are being honest with their reports.
But determining truthfulness is no easy task, of course.
“Most people think it is about body language cues,” said Jason Voss, content director at the CFA Institute. “However, there's been lots of scientific research done over the years and definitively, body language cues just don't work.”
According to Voss, trying to determine a CEO’s truthfulness by looking for cues on, say, a video interview only works 54% of the time, or a little bit more than a 50-50 guess.
Instead, investors can use a couple of other methods to clue them in on whether they’re being dealt with honestly, said Voss, a former fund manager.
“One thing that you can rely upon is text-based analysis,” Voss said “It's usually generated by a computer algorithm or very knowledgeable human being who looks at the text in, say, a press release or a 10-K [or] an annual report, and they evaluate the truth of the statements coming out of management.”
New York–based Rittenhouse Rankings is one such company that conducts this type of analysis. “They've created a stock index which tracks the top ten firms that have the most candor,” he said. “It outperforms the S&P consistently. So this is pretty good proof that their techniques work.”
Another company, LIWC, has a website that lets users cut and paste text which to be analyzed.
“You can feed in the text of these annual reports and these press releases, and it will evaluate the veracity of these statements,” said Voss. “These techniques, on average, are 70% effective, which is a far better chance than you would have if you were relying upon body language.”
[For the record, this article had an authenticity score of 31.4 points versus an average of 24.84 for professional or scientific writing using LIWC’s methods.]
Strategic Use of Evidence (SUE)
Voss also recommends strategic use of evidence. “This is the cutting edge technique in interrogation,” Voss said. “It’s being taught to the Israeli Mossad and it’s being taught to the CIA.”
Here's an example of how it works: rather than confronting a CEO with a tough question right away, this method starts off with relatively light inquiries and slowly builds up to the tough stuff to confirm a suspicion.
Voss said this method delivers veracity about 70% of the time, with some studies showing it coming in as high as 82%.
“Gradually, with question after question, narrow the context of your questions down to something that you're really concerned about answering," said Voss. “This is almost like handing rope to people that they can hang themselves with.”
More from Yahoo Finance