Smart Investments: 4 Warning Signs That a Company Will Fail
Using your money wisely for investments means doing a little digging online. One of my favorite tools is the annual Form 10-K. I always check for four warning signs that say a business is doomed to crash and burn. They’ve never failed me.
1. Ongoing Losses and Cash Flow Problems
Every corporation needs good cash flow to stay healthy. This includes positive revenue, smart investments for growth and excellent credit management.
Negative net income (the money left over after taxes and expenses) isn’t a bad thing if the
business is using capital to invest in growth, such as expanding production facilities. If the profile shows years of losses and capital only used for operating expenses, however, it means the revenue, market interest or management skills just aren’t there. Don’t waste your time and money.
2. Low Current Ratio for Interest Payments
The current ratio is the measure of a company’s ability to pay off debt obligations. Many
companies take out loans to drive expansion or increase available liquid capital, so having debt obligations in themselves aren’t a problem. A current ratio higher than one is good news; it means there are sufficient assets to make interest payments. If you see a ratio much lower than one, however, it means the company is starting to drown in debt.
3. Sudden Changes to the Auditing Firm
All publicly traded companies must be audited by a third party, and businesses have the freedom to change auditors. That said, I’ve learned to be very suspicious of any changes to outside auditing. And if the corporation dismissed an auditing firm DURING the annual audit?
That should make the hairs stand up on the back of your neck.
This often means management is trying to twist the way the books look to make things appear more rosy to investors. Sometimes, it’s a sign of outright fraud coverups. Either way, get out right away.
4. Bad Leadership
An investment is only as good as its CEO. Just like a ship needs a great captain to navigate
turbulent waters, a company depends on its CEO to make wise decisions and stay afloat. If this person isn’t equipped to lead, the company is in for rough times. Here are a few major red flags:
• No communication: Is the CEO hiding out, hoping to avoid the fallout from bad decisions?
That’s never a good sign.
• No transparency: I always expect 100% honesty from CEOs. If they straight out lie to
investors or try to hide losses, it means big trouble.
• No clear goals: A startup can have a great idea at launch, but that won’t drive long-term
profits. Does the business have a roadmap with specific goals and methods for getting
there? If not, they’re going to be lost at sea.
One of the biggest “sell now” warning signs I look for is management departures. It’s one thing for a business to hire fresh talent from time to time, but if multiple longtime directors jump ship, you should too.
The Three Ps for Smart Investments
When investing in startups or other businesses, always look for three things: passion, planning and popularity. A new company, or even one that’s going through a rough market patch, can be viable if its CEO has the drive to succeed, clear goals for growth and an idea that really appeals to people. These are the businesses that may be worth taking a chance on.