Wirecard
A payment-processing company listed on Germany's DAX collapsed in 2020 after roughly €1.9 billion held in trust accounts couldn't be located. The stock lost practically all its value.
Wirecard was seen as a German flagship company for years and joined the DAX index in 2018. In June 2020, the company announced that bank balances of roughly €1.9 billion most likely didn't exist. An insolvency filing followed shortly after.
The lead-up is remarkable. Financial Times journalists had published doubts about the numbers for years. The response, for a long stretch, was to attack the critics rather than examine the allegations. At one point, short selling of the stock was even temporarily restricted.
For investors, the loss was total. Anyone who bought at the peak lost practically everything. Unlike an ordinary price decline, there was no recovery, since no company value remained.
What follows from this is uncomfortable: neither inclusion in a well-known index, nor being audited by a major accounting firm, nor years of price gains are proof that the numbers are correct.
The case exemplifies the value of the cash flow statement over reported earnings. Substantial parts of the reported business ran through third-party partners, whose revenue was held in trust accounts. A growing share of earnings therefore stood against balances not directly available to the company. This combination of strong earnings growth and weak operating liquidity is exactly the warning sign described in the balance-sheet lesson.
For portfolio construction, the lesson is the distinction between market risk and individual-stock risk. The failure of a single stock is barely noticeable in a broadly diversified index, while it's existential in a concentrated portfolio. Since individual-stock risk earns no premium, concentration here is unpaid risk.
On the regulatory side, the case led to reforms of financial reporting oversight and financial supervision in Germany. For investors, though, the practical consequence remains limited: oversight and audits raise the probability of detection, but don't guarantee it. The only reliable protection against a single company's failure remains diversification.
Summary
- Index membership and an audit opinion are no guarantee the numbers are correct.
- Earnings growth with no matching cash flow is a warning sign.
- Only diversification protects against a single stock's failure.
Did you get it?
What warning sign was built into the numbers?
Strong earnings growth alongside weak operating liquidity, with balances held in third-party trust accounts.
Why didn't DAX inclusion help investors?
Index membership says nothing about whether the numbers are correct, it follows from size and tradability.
What protection remains against a case like this?
Diversification. Individual-stock risk isn't compensated and can be fully diversified away.
Sources and further reading
- Public company announcements from June 2020, Financial Times reporting, and the reports of the German Bundestag's investigative committee.
Related
- Reading a balance sheetStage 3
- EnronCase Studies
- The dot-com bubble, 2000Market History