Picking the right stocks in the market to invest in is not an easy task, and your success in picking the right ones is not always guaranteed.
Be that as it may, these eight signs can help you determine if a stock is getting set to crash.
1. If the company has a negative cash flow.
Cash flow is a company’s lifeline. When a company’s cash payments are bigger than its receipts, it means the company has a negative cash flow that can eventually lead to insolvency.
2. High Debt to Equity Ratio
A debt-to-equity ratio measures a company’s bankruptcy risk by comparing its long- and short-term debts to its shareholders’ equity. A high ratio usually means the company has been aggressive in financing its growth with debt. Eventually, this debt can become too much to handle.
3. Interest coverage ratio
The interest coverage ratio reveals if a company is having difficulty paying its debt. If a company’s ratio is below 1, it can’t meet its debt obligations with the period’s earnings before interest and tax.
4. The usual share price decline
The fourth sign is a decline in share prices. A sustained decline almost always precedes a corporate collapse. As an example set in the US, Enron’s stock started falling 16 months before it went bust. But also, a declining stock can signal a buying opportunity. Consider the next four signs to distinguish between a collapse and an opportunity.
5. Listen to profit warnings
Profit warnings should be taken very seriously. Growing evidence suggests markets under-react to bad news. Don’t forget to always listen to analyst calls, as you can glean very useful information from the questions being asked by analysts who cover the stock.
6. Watch out for stock market activity of the company owners, directors or executives
Companies must divulge insider trading, as in the purchase and sales of shares owned by substantial shareholders or directors. They have the most current intel, so heavy selling or buying can be a sign.
7. Sudden exit of key staff of the company
The sudden resignation of key executives or directors can also be a bad sign. Companies may sack a key executive as a sign that the company has had a terrible misstep and is making management changes as atonement, or as a sign of realization that management has been under-performing.
8. Investigations by regulatory bodies
Finally, formal investigations by regulators such as SEC, frequently precedes a collapse. Companies may dabble into wrongdoing in order to stay afloat when they get into financial distress. When the company is being investigated, it is very likely that they have been caught in the process, and will pay for their crimes. And the shareholders will ultimately suffer for it.
