How to work out if a company is in trouble

Carillion, Lehman Brothers, Royal Bank of Scotland, Enron, Northern Rock and many, many more. There’s a long list of companies that have suddenly got into trouble and left shareholders nursing big losses or with nothing at all. But can you spot trouble coming before shares tumble?

The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results

You don’t have to be an accountant to know how to spot the warning signs of impending trouble in company reports. You do need to do your research, but signs that a company is not doing well are mostly obvious.

The recent experience of the cut price drinks wholesaler and retailer, Conviviality, caught some traders and shareholders unaware. Chris Boxall, from Fundamental Asset Management, tells IGTV that the tell—tale signs were there to be seen.

When undertaking investment research, especially for recently quoted companies, begin with the stock exchange admission document. Then you need to look at the company reports that come out through the year. Amongst the ‘red flags’ here are a drop in margins. Companies may be increasing revenues, but at what expense? If costs rise as business increases turnover, it can only mean one thing in the long term: the business model is flawed.

If a company abruptly changes strategy, uses exceptional costs regularly, or has poor cash flow, then these should ring alarm bells too. Boxall also watches for management which does not have ‘skin in the game’. Little or no equity interest from senior management and ‘architects of strategy’ should be a warning.

Quoting Warren Buffet, Boxall says that even good management can't turn around a poor business.

'When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact,' — Warren Buffett.

But what about the areas where investors should feel encouraged? Boxall says that, broadly, it is the opposite of the above: there should be a focussed strategy with, preferably, organic growth in attractive markets that are also expanding. Also watch director dealings — if directors are buying the stock of the company they are in charge of, it can only mean one thing.

This is meant as a rough guide. As ever, do your own research and keep an eye out for the red flags.

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