Are worried that your stocks may be doomed without your knowledge? Believe it or not, there might be warning signs that it’s about to happen.
A lot of people think that the drop of a company’s stocks is always a random occurrence that can’t be detected early enough – but the truth is, that’s not the case.
To experts, the warning signs are always written all over the place, but to a non-financial jargon, things always look fine; well, until they are not. But if the financial analysis is not your favorite part of investments, don’t worry, we’ll fix that in a moment.
But understand this first…
Even the best of investment gurus sometimes never foresee drops in the stock prices of certain companies.
You remember how big Yahoo was over two decades ago, right?
Well, according to this article by Business Insider, their real worth today is far behind what most of its new rivals would consider being a “fair” competitor to them.
The point is some companies that were worth trillions yesterday have been wiped out today and those that still exist are barely breaking even – and their collapse or drop in market share normally hits their shareholders by surprise.
And even the “big fish” shareholders with inside tracks are sometimes caught off guard leading to massive losses resulting from a decline in the prices of the shares they hold.
At this point, you’re probably wondering whether there are sure ways of knowing if your stocks are on a crash course to nowhere; and the straightforward answer is yes. Look for warning signs.
There are a number of proven ways of telling whether the stocks of a certain company are on a downturn.
7 Warning Signs That A Company’s Stocks Are Set To Plummet
1. Negative Cashflow
A company’s share certificate can only mean something to the holder if the company has sufficient cash flow to sustain its operations.
Cash flow is a company’s lifeline; each and every investor should have a keen eye on the cash flow activities of the company they invest in.
Whenever a company records a negative net cash flow in its Cashflow Statement, it means cash payments are more than cash receipts. It’s one of those warning signs to heed.
If the same is reported for a longer period of time, it means the company’s bank accounts are being drained and it may soon be impossible to sustain the company’s operations. And more often than not, companies operating along these lines have two options; they can either raise additional funds from investors or lenders or shut down operations due to insolvency.
2. Interest Coverage Ratio
On its own, the Debt/Equity ratio does not reflect much of the company’s operations. Abbreviated as D/E, the ratio makes more sense when accompanied by an evaluation of the debt interest coverage ratio.
Consider this example:
An enterprise reports a D/E ratio of 0.60 during a certain quarter of the year which shows that the firm is safe from bankruptcy. In addition, the same company has an interest coverage ratio of 0.50. Interest coverage of less than 1 indicates the inability of a company to meet its obligations as they fall due in the reported period.
Further, an interest coverage ratio of less than 1 indicates that a company is not able to meet its debt obligations.
To track this key figure, you can use for example the free stock screening tool finviz. The free scanner functionalities are sufficient to give you a quick overview of the current company figures like the D/E ratio and the debt-equity ratio as well.
3. Alarming Debt-Equity Ratio
Distressed companies borrow at very high-interest rates due to their perceived risk by financial institutions. The huge repayments of loans taken can strain a firm’s cash flow, ultimately leading to a default in the repayments.
In this case, debt repayments end up draining any returns of the company, leaving little to no amounts being set aside as retained earnings which normally boost the capital base.
The debt/equity ratio can reveal the risk of a company running into bankruptcy. The ratio makes a comparison between the debts (long-term and short-term) and the shareholder’s equity. Basically, a ratio of 0.5 and above is a red flag and needs a closer look.
4. Share Price Trend
The price of a company’s shares can speak volumes about its status. If the share price decreases when the industry is generally stable, it can be a sign of things going south.
More than 90% of companies that end up closing shop recorded a decline in share prices months or years before. For instance, Enron, which collapsed in 2001, had a peak share price of $96 only to end up with $0.26 by the time it was being wound up.
However, a sharp decline in the price of a company’s shares is not in itself an indicator of bad times ahead, it might be an opportunity to buy at a low and sell at a high later on. Be sure to include other parameters when analyzing the status of such companies.
These are warning signs to look out for.
5. Insider Trading
This is one of the surest ways for any reputable company to lose its public image. Most jurisdictions require companies to issue public reports in case of a purchase or a sale of a substantial amount of the company’s shares.
Directors and managers of a company have the most vital information about the status of the firms, any abrupt selling or buying of shares by one or two groups within the company can be a red flag.
When insiders sell their shares, it can be an indicator of tough times to come.
6. Profitability Warning
A Profit warning is a serious indicator of a company’s financial status.
Declining profits or increasing losses always cause an instant reaction in the market, with most investors opting to sell off their shares.
With time, the market systematically tends to under-react to the negative news. Consequently, negative news regarding a company’s profitability is mostly followed by a decline in stock prices.
As mentioned earlier, you can use the finviz stock scanner to analyze company key figures for free. However, there is another cool stock screening tool available that has a free plan as well. It’s called TradingView. Along with fundamental data, there plenty of opportunities to visualize your favorite stocks with charts.
Continue reading the TradingView Review to learn more about the 5 reasons, why their free trial is an excellent choice and why the free version is a must-have for every investor.
Companies that are facing problems are always investigated by regulatory authorities such as securities exchanges and tax authorities. These investigations normally precede a company that is about to undergo hard times.
It is not surprising to see companies break the law as a result of difficult financial or economic times.
And even if these investigations turn out to be unfounded, such authorities always leave the investors with more questions than answers regarding whether or not they should dispose of their shares in the company.
There are numerous other ways one can know whether or not the stocks of a company are about to go down. However, these are some of the key red flags you need to watch out for to enable you to avoid losing the value of your investment.
Of course, these metrics can only be relied upon to a certain extent.
There is also an interesting approach to protect you from sudden price losses overnight. In day trading, for example, you don’t hold your stock positions longer than a few minutes or hours.
But is day trading for beginners a good idea at all? Ultimately, day trading is just an addition to existing investment strategies. The risks are high, and so care should always be taken to trade with caution.
Either way, it is crucial for you to involve a financial expert before drawing your conclusions about a company’s stocks.
Like I mentioned earlier, even the experts can be wrong on this so be sure to rely on both your knowledge and that of a professional to make an informed decision.
Profits do not grow on trees, and it is incredibly important that you are aware of the risks of investing at all times.