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Thursday, 14 May 2009

Signs A Stock Is Ready To Slide

Glenn Curtis

A company might be a poor candidate for investment if it generates subpar earnings, or has weak cash flow or perhaps a flimsy balance sheet. But there are also other characteristics that can be major turnoffs and harbingers of unpleasant things to come. Keep an eye out for these clues that the other shoe might be ready to drop.

Missing an Already Lowered Forecast
It is not uncommon for publicly traded companies to lower the earnings guidance that they provide from time to time. Companies may do so when the macroeconomic situation darkens or when a company-specific issue arises. That said, when a company sets the new, lowered, earnings bar, it is important that they clear it and do not miss the revised forecast.

Why? For one, if the company does not meet the new projection it can have a negative impact on the morale of retail and/or institutional shareholders and their ability to trust management. In other words, it can leave shareholders and those sitting on the fence wondering what the future may look like on the earnings front. Secondly, the analyst community could end up bashing the company or its stock as a result of this missed forecast. They may seriously scale back their estimates and perhaps lower their rating on the shares. This in turn could have a negative effect on the share price.

Selling Near the Lows
It is also not uncommon for insiders at publicly traded companies to sell shares of their company's stock. And to be clear, there are often some very legitimate reasons for executives to unload their shares. For example, they may have to make tuition payments for their children, or perhaps they are in the process of buying a home and need funds. Other times, an insider may sell shares simply to book some profits and/or to diversify their holdings.

But there are some times when certain insider selling activity or transactions should raise a few eyebrows, such as when a group of executives suddenly decides to sell off a portion of their holdings. Individuals who sell a very large portion or percentage of their total holdings may also raise some flags, as well as insiders that sell at or near 52-week lows.

Executives that do sell near or at the lows seem to be saying that they think their money might be better deployed elsewhere. Again, this may or may not be true and it's unlikely that an executive or insider would admit to that. However, unloading shares at rock-bottom prices does sometimes convey that signal to the investment community.

Mum's the Word
It isn't always easy to provide the investment community with quarterly or annual financial forecasts. After all, corporations are large entities and the business environment can change rapidly over time. Plus, there is the chance that expected revenues could be pushed back to future quarters or bumped up. However, that doesn't mean that companies should not try to provide guidance; many retail and institutional investors like this type of handholding.

That said, one signal that trouble may be brewing is when a company abruptly discontinues its guidance. Doing so may signal that the company has no idea or doesn't expect to have an idea of when earnings could come in. Along those same lines, such silence may signal that macroeconomic or company-specific forces may have a huge impact on forward earnings, making an accurate forecast impossible. Neither scenario is particularly encouraging. But even beyond earnings guidance, a company that isn't forthcoming and doesn't update the investment community about its progress (or lack thereof) may be trying to sweep bad news under the rug. That's not always the case, but it's something to think about.

Dividend Cuts
Companies that pay dividends can be a big lure, particularly for income-oriented investors. In addition, the fact that a company pays a dividend is also often viewed as a sign that a company is doing well. However, when a dividend-paying company suddenly suspends its dividend, it may signal that the company is experiencing some sort of financial trouble. Also, by stopping the dividend, the company may see a fair amount of selling of its stock and turnover in its shareholder base as income-oriented investors unload the shares. Finally, a dividend suspension may come in advance of serious job cuts, plant closures or asset sales.

Halting Repurchases
If a company has been repurchasing shares and suddenly stops, it may signal that the company is short on cash or that it thinks that the shares aren't a good investment at the time. Frankly, neither scenario would be attractive.

A One-Trick Pony or Lack of Diversification
In order to be successful and achieve growth over time, it's important that a company introduces new products and remains innovative. Companies that don't innovate run the risk of becoming irrelevant if a superior product or improved technology hits the market. It's also highly important for a company to diversify its product offerings. The reason for this is simple: if a company were to stick to one product line or a small number of lines that run out of steam, that company could more easily go out of business. Long story short, keep a lookout for, and be wary of, companies that are stuck in neutral. This means companies that aren't coming out with new products and keeping up with the competition or companies that bet all their chips on the success of one product line.

Industry Indicators
Companies that operate in the same industry (for example, the auto industry) may experience similar trends. If one company is struggling in a certain market, its competitor may be as well. Investors should be on the lookout for signals of how the company may be doing from other industry participants. As an example, suppose an investor was to note that a competitor was experiencing a decline in margins in its European business. In such a case, it might be assumed that other companies are seeing the same kind of decline. On the flipside, a company experiencing a huge influx of orders from a region may be a sign that other companies in that industry are experiencing similar trends. Keep an eye peeled for industry trends as this could signal what is around the corner.

The Bottom Line
There are several indicators in addition to traditional valuation metrics that may signal trouble to come for a company's stock. Investors with a sharp eye and a willingness to do research may be able to limit or prevent losses because they see a shoe about to drop.

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