Investing in the stock market involves much more than just looking at the prices on Wall Street. The most successful investors and fund managers are constantly looking at company performance and internal indicators that suggest a business could be in trouble. Spotting the signs early can make the difference between getting out ahead or waiting too late before a stock eventually bottoms out.
No matter how successful a company has been in the past, no business is immune to failure. If you want to have the best chance of spotting a company in trouble, then these are five key factors that you need to watch out for.
1: Significantly More Debt than Equity
There are advantages to borrowing and all the highest performing companies have some form of debt. The time that debt becomes problematic is when it exceeds the equity that a company has. Too much debt will mean relying on future income, and because income cannot be guaranteed, this can leave a company in a very vulnerable position.
High debt to equity ratios are classic signs that a stock will decline in the future as investors lose confidence.
2: Profit Warnings During Investor Calls
Quarterly investor calls are essential when gauging the health and prospects of a company. Profit warnings during an investor call are massive red flags that suggest tough times ahead and could mean that it is time to sell. Stay open minded following profit warnings, particularly if a company has a strong plan in place to return to profitability. However, if you don’t have confidence that the company can turn things around, then it is often better to look for other investments.
3: Steep and Sustained Share Price Decline
A lack of investor confidence can crush a publicly traded company. Sudden and sustained declines in stock value should be a warning sign to sell. If you catch the decline early, then you will often be able to get out before value tanks and you lose all your initial investment.
4: Low or Negative Cash Flow
Even the companies with the highest reserves cannot sustain negative cash flows forever. A company can become insolvent after an extended period of suffering operating losses. During these times, a company will seek capital through loans or stock sales, but if you can see that a company is desperate for capital then it could be time to cease future purchases or sell your stock altogether.
5: Executive Resignations
Resignations from key executive positions can signal inner turmoil. Sudden unannounced top-level resignations are particularly worrying. This suggests a lack of confidence from within, and sudden departures can send stock prices down.
Company in Trouble? Don’t Ignore the Warning Signs
Companies may display one or more of these warning signs and still manage to turn things around. Ultimately, the decision to sell will involve instinct, your own risk assessment, and your knowledge of a company.
It’s critical to stay up to date with every company that you invest in. Ignoring financial reports, investor calls, and key changes in an organization can leave you vulnerable to financial loss if stock values eventually fall.
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