How to Spot Companies Headed for Trouble?

By digging little deep into company activities and financial statements, even an average shareholder can identify the risks involved. There are certain guidelines that are very useful in spotting companies that may be headed for trouble.

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What’s the Story behind Stock Price fall?

Investors should keep an eye on share price declines. History proves that almost all companies that witnessed a collapse were preceded by a sustained share price collapse. Decline may also signify a wonderful opportunity to buy an out-of favour business. But you need to correctly judge the reasons behind a share price decline, so as to take a right call on whether the stock will recover or if it’s dead meat.

Taking Cues from Company Cash Flow

This may be considered as the lifeline of the company. When the cash payment of the company exceeds the cash receipts, the company’s cash flow is negative. It should not occur for the sustained period. In this situation, the company finds itself insolvent unless it does not get fresh investment from shareholders or lenders. Even profitable companies can have negative cash flows. This happens with the companies because of certain factors.  Mainly if they have large investments in stock, staff and manufacturing plants, cash flows can go negative for some time. There may be some delay when company can make profit out of this investment which can cause sales growth, large quantities of stock or staff end up sitting idle in the warehouses and thus causing a devastating impact on cash flow.

Keep a Close Watch on Resignations

The sudden resignation key senior staff can also result in bad news. Although these departures are genuine but still a close watch is essential. One should be careful about the resignations or replacement of auditors. It is said that auditors are the first to jump the ship if there are clouds of distress on company environment.

Tracking Insider Trading Activities

It is the responsibility of companies to announce the sales and purchase of shares by company’s directors.Executives and directors have the most up-to-date information on their company’s prospects, so heavy selling by one or both groups can be a sign of trouble ahead.

Concerning Debt Levels

Struggling companies have higher risk of defaults, so they may pay higher rate of interest to borrow money. As the result, this debt tends to shrink their returns in certain cases. To keep an eye on this we have total debt-to-equity as a useful tool to measure the bankruptcy risk. High debt companies have higher D/E ratio as compared to low debt companies. According to market study it is said that companies with D/E ratio less than 0.5 carry low debt. So the conservative investors should give a close look on their debt levels.

Seriousness of Profit Warnings

Investors should take profit warnings very seriously. May be the market reaction appear little swift and brutal, there is a growing evidence to suggest that the market systematically reacts to under bad news. It may sometimes followed by gradual share prices decline.

It is always advisable to stay alert of unusual activities. Mind it; it’s your business to know the company’s business you are invested in. This really minimizes the risk of getting caught in a corporate train wreck.

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