3 Possible Indicators of a Company Facing Trouble Ahead

When we read through most annual reports, we tend to only hear about the good things happening at the company. Often, it would be a little too late for us as investors when the problems actually do surface as we would have to take painful losses.

In light of that, are there any factors we can focus on to warn us of choppy waters that might just lay ahead? Is it possible to get an idea of the challenges facing companies like SMRT Corporation (SGX: S53) or Neptune Orient Lines (SGX: N03) even before all the problems (such as shrinking profit margins for the former and an industry-wide capacity glut for the latter) became obvious?

Burning cash and leveraging rapidly

One of the main objectives any company has is to generate cash from its daily business activities. Therefore, if we start seeing a company leaking cash like water from a cracked barrel and using debt to try to plug the leak, it is a major sign that all is not well within the company.

However, if the company is actually using cash for investments to grow its business, investors might want to view the cash burn as a positive sign.

Trimming of dividend

Consistent dividends are normally a major reason for investors to invest in a company. Thus, management would always want to treat the dividends issued by their company with utmost care. If a company chooses to cut its dividend, we might not be too far off the mark to assume that management is really left with little choice. A company pushed into a desperate situation can hardly be advantageous for shareholders.

Top management “abandons the ship”

In most markets, there are strict rules to regulate insider trading. This is essential as most insiders within a company should have a much better understanding of the challenges a company faces. For this reason, when there are major changes in the management of a company, investors ought to be alert to the possibility that a company’s business is not at a very cozy point in time.

Foolish Summary

Some of the points discussed above are certainly not perfect indicators of a company in trouble. We should always view the situation from many perspectives and form our own view. Before we invest in any company, it is important for us to run through all the possible risks a company might be facing. In this way, we are less likely to be caught off-guard when bad news arrives.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.