How do you find out if a stock you own or want to own is worthy of holding? There are signs you can look out for that serve as warning bells. They are:
- Negative cash flows
Cash flow is the lifeblood of a business. The P&L statement are based on accrual and credit basis (due to accounting standards). Thus, not all the profits shown are actually in the company coffers. Some are still not received (as shown in an increase in accounts receivables). So, looking at “cash flow from operating activities” under the cash flow statement shows the real profitability of the company. Profits can be increasing but cash flow decreasing year after year for a few consecutive years is a major warning sign.
- High debt-to-equity ratio
Debt-to-equity ratio is total liabilities divided by the shareholders’ equity. A high number (above 0.9) equates to high debt levels.
- Insiders selling
When the company directors and fund managers are selling in huge chunks, you certainly want to flee as well. Add that to the negative cash flows and you have a recipe for disaster.
- Resignations of auditors and key management
Resignation of key officers especially the Chief Financial Officer without a concrete reason has to be looked into. Resignations of auditors all of a sudden has to be investigated as well.
- SEC/SGX investigations
When the authorities step in, something really disastrous might be happening for the company. By then, the share prices would have plunged. The first warning sign would already have come from the negative cash flows year-on-year for a few consecutive years.