- The Big Picture - http://www.ritholtz.com/blog -

Red Flags

Posted By Barry Ritholtz On February 23, 2005 @ 11:57 am In Investing | Comments Disabled

Hewitt Heiserman, author of "It’s Earnings That Count [1]," (mentioned previously [2]), weighs in on the exit strategy discussion from earlier. While I have a few rather different strategies use in temrs of price action, I particularly appreciate Hewitt’s Fundie metthods of getting out of dodge:



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock price   Sell 50% if stock drops 15% below purchase
  price; sell other 50% if drop 25%
                         
    Write down in notes sell points                                  
                                             
Income statement   Earnings announcement falls short of consensus                              
    (studies indicate the effects for as long as a year
  after the announcement)
                         
    Last two quarterly earnings growth slow                                
    Other revenue rises without explanation (especially
  if company uses distributors for international sales)
                   
    Same store sales down 3% in last quarter                                
    New store results are disappointing                                  
    Earnings miss unless a one-off, temporary problem
  (the first disappointment usually followed by another miss)
                 
    Company announces worse-than-expected earnings                              
    Options, additional share offerings, conversion of
  convertible bonds result in massive dilution for existing stockholders
                 
                                             
Strategic   Big price cuts on flagship products which does not
  result in market share increases
                       
    Company embarks on acquisition spree                                
    Company buys another company in an industry they
  know nothing about
                         
    Company using acquisitions to bolster revenue growth                              
    Change in business model; e.g., switch from
  all-company-owned store structure to franchise
                     
    Market is closing; e.g., Dayrunner organizers when
  PDA’s became popular
                         
                                             
Valuation   P/E ratio of 30, when most optimistic projections
  of earnings growth are 15-20% for next few years
                     
    Company sells at higher P/E than its growth rate?                                
    No room for minimum 5% annual returns next 3-5 years                              
    Is P/E ratio greater than 1.5x the market’s
  multiple?
                             
                                             
Technical   Relative price strength trending down                                  
    Company in a lagging industry as measured by
  industry relative strength (source: IBD)
                       
    No support at 50-, 200-day moving average                                
    Is company breaking down badly and not rallying
  well vis-à-vis the S&P 500, Dow and Nasdaq?
                     
    (William O’Neil 4/04 issue of AAII Journal found
  when market leader finally tops, it will decline avg. 75%.)
                   
    Money flow or accumulation/distribution index
  deteriorate
                             
    Compare a stock’s money flow on a relative basis
  and compare its current level to historical norms (Bloomberg, BigCharts)
               
    Industry market leaders are topping out                                  
    After months of significant price advance, a stock
  runs up faster than normal in just one or two weeks
                   
    Stock shows downside gaps, usually indicating many
  institutional sellers present.
                       
    Stock exhibits deteriorating relative strength,
  suggesting the stock is beginning to lag the overall market.
                   
    Earnings fall short of expectations or fundamental
  strength deteriorates.
                         
                                             
Stock   Splits for the second time in less than 12 months                                
    Secondary offering priced at discount to current
  stock price and carries warrants that can dilute EPS even more
                 
    (Sharp underperformance of companies following
  secondary issue)
                           
    Private offering in convertible notes because it
  dilutes earnings per share
                         
    Company with large cash flow keeps buying its stock
  back at rich multiples as growth in organic revenue slows
                 
                                             
Management   Best story is stock performance rather than
  business.
                             
    Top executives and some key employees go to rival
  firm
                             
    New management team that hasn’t proved its bona
  fides
                             
    Business conditions described as
  "challenging"
                               
    Investment banker hired (are they trying to protect
  their cushy jobs?)
                           
    Company files extensions for reporting earnings                                
                                             
Other   New competitors entering the market?                                  
    Customers changing spending habits?                                  
    Price war erupted in industry?                                  
    How are other companies in same industry doing?                              
    (Red flag when one company in industry doing much
  better than its peers)
                         
    Cut losses short, as they can be overcome. Big
  losses do severe financial/psychological damage that are harder to recover
  from.
               
                                             
Stores   Decline average weekly stores sales                                  
                                             
Other:   Management significantly reduces sales, earnings
  forecasts
                           
    Competitor says business is tough                                  
    Negative same-store sales growth                                  

Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2005/02/red-flags/

URLs in this post:

[1] It’s Earnings That Count: http://www.amazon.com/exec/obidos/ASIN/0071423230/thebigpictu09-20/002-8088463-8433620

[2] previously: http://bigpicture.typepad.com/comments/2005/02/nine_basics_of_.html

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