When evaluating a stock for a potential investment, there’s lots to consider — some of which we’ve already briefly gone over. But part of determining which stocks you should buy is … well, determining which stocks you shouldn’t buy.
So how do you go about doing that? Well, there’s the basic numbers we’ve discussed before — just like they can help you find attractive stocks, they can help point out the stinkers, too. But there’s also a few events that can serve as pretty loud warning signals.
This isn’t to say every company goes through one or more of these issues can’t be a decent buy. (In fact, because these events usually spark selloffs, they sometimes can become value plays.) Regardless, you should proceed with caution if you spot any of these waving red flags on the horizon. Take a look:
Every fiscal year, a company reports earnings four times — known as quarterly reports. This happens like clockwork, with the first three quarters filed as 10-Qs and the final quarter tied into the annual report, filed as a 10-K.
In general, companies are required to file their quarterly reports no more than 45 days after a quarter ends, while twice as much time is given for an annual report. Companies usually announce the day they will report earnings ahead of time (such a calendar can be found on Yahoo! and other sites). As of this writing, for example, Alcoa (NYSE:AA) was slated to kick off first-quarter earnings on April 8.
Sometimes, though, companies delay their earnings reports. Last month, small-cap Avid Technology (NASDAQ:AVID) delayed its release, citing “an unspecified accounting problem.” Basically, that’s PR jargon for: Things aren’t adding up like we hoped. And that’s exactly why investors tend to flee when news of a delayed filing hits. (Avid shed 9% on the news.)
Filing earnings is a routine requirement, so any complication is unsettling — save a legitimate crisis like Hurricane Sandy. Because in other cases, either something unexpected popped up on the balance sheet … or the business can’t properly and punctually execute a basic task. Either one doesn’t sound too promising.
Of course, it’s not always a huge issue. Tesla Motors (NASDAQ:TSLA) also made a similar announcement a few days prior to its report, but it was quick to add that its accounting errors wouldn’t affect its already-posted earnings results. Still, if you hear a company you’re eying or own has delayed its filing, be sure to give it your full attention.
When it comes to quarterly reports, an earnings “miss” is another thing to watch out for. Every quarter, companies also issue guidance for the coming quarter … and tend to update it as they go. Based on that guidance and other factors, Wall Street analysts project the earnings they expect for the current three-month period (or full-year, if it’s the final quarter).
Generally, Wall Street’s expectations are pretty reasonable, as more than half — 62%, to be exact — of companies tend to “beat” the consensus, or average, estimate. In the fourth quarter of 2012, for example, 70% of S&P 500 companies topped analyst estimates.
Thus, even if a company is struggling — or projected to lose money — it can still outperform Wall Street by posting a smaller-than-expected loss or shrinking but better-than-expected profit. And analysts continually revise their estimates heading into the report, so it’s unusual that the bar is set unreasonably high.
For example, shares of online music company Pandora (NYSE:P) recently shot up on news that it reported a loss, excluding items, of 4 cents per share for Q4. That was even worse than the 3-cent loss the year before … but better than the 5-cent loss that Wall Street analysts expected.
One-time tech darling Apple (NASDAQ:AAPL), on the other hand, managed to grow profits during its Q4, reporting earnings of $8.67 per share back in October. Analysts, however, had slated $8.75 per share — that discrepancy further fueled the stock’s downward trend.
A dividend is money that is repaid to shareholders — something we recently discussed in terms of tax implications. Many companies try to increase the amount they pay out year after year, both as a way to continue to entice shareholders, but also to demonstrate company stability. Sometimes, however, companies in a difficult financial situation decide to reduce the amount they pay out to investors each month to preserve cash. Thus, a dividend cut often is perceived as a last-ditch move for a floundering company.
Struggling retailer RadioShack (NYSE:RSH), for example, eliminated its dividend altogether last summer in the face of big losses.
Rule of thumb: Investors love dividend increases, and they downright hate dividend cuts. Many dividend investors will simply dump a stock when that once-guaranteed income is lessened or taken away altogether.
When RadioShack announced its dividend suspension, the stock plummeted an ugly 30% — in one day. Think it wasn’t a bad sign? You can argue that RSH has been climbing of late, but it’s still off about 10% from where it was back before it hacked its payout, and the company posted a loss again in the most recent quarter.
Sometimes, issues beyond the company’s control can play a role, like the general economic landscape. In January, for example, 44 companies cut their dividend, thanks in part to general economic headwinds and increased taxes. That’s far more than the average of 10 companies per month in non-recession times.
And again, dividend cuts aren’t always the kiss of death — just ask Avon (NYSE:AVP), which actually is up 33% since its November dividend cut despite an initial selloff.
No matter what, though, a dividend cut is a red flag — no one cuts their dividend because things are peachy keen. The important thing is to see what the company plans to do with its newly freed-up cash — but even that potential should be considered with a clear dose of caution.
As of this writing, Alyssa Oursler did not hold a position in any of the aforementioned securities.
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