GuruFocus has just released a feature called Warning Signs. We
conduct a thorough checkup using a checklist of 32 items that
cover the areas of financial strength, profitability, growth and
valuation of each company. We highlight the warning signs in the
summary box. An example with First Solar (
FSLR
) is below:
The purpose of the warning signs is to warn you that the company
may have red flags in these areas so that you don't overlook
these areas. These warning signs do not necessarily mean you
should not invest in the stock. But you should be aware of them
before you invest.
If you click on the warning signs button, you will be brought to
the "analysis" page where the details are displayed. In the case
of First Solar, the Severe Warning Signs are:
Warning Signs with First Solar (
FSLR
):
Financial Strength: Poor
First Solar Inc. displays poor financial strength. Usually this
is caused by too much debt for the company.
Altman Z-Score: Distress
Altman Z-score of 1.09 is in distress zone. This implies
bankruptcy possibility in the next two years.
Piotroski F-Score: Low
A Piotroski F-Score of 1 is low, which usually implies poor
business operation.
Interest Coverage: Extremely low
Ben Graham prefers companies' interest coverage be at least 5.
First Solar Inc.'s earnings cannot cover its interest expense. If
the situation continues, the company may have to issue more debt.
Long-Term Debt: Keeps issuing new debt
First Solar Inc. keeps issuing new debt. Over the past three
years, it issued $620.41 million of debt.
Asset Growth: faster than revenue growth
If a company builds assets at 28% a year, faster than its revenue
growth rate of 6.8% over the past three years, it means that the
company may be getting less efficient.
Days Sales Outstanding: Building up
If a company's sales outstanding increases, it means it has
difficulty collecting payment from its customers.
Days Inventory: Building up
If a company builds up inventory, it may mean it is having
difficulties selling its goods.
And the two medium Warning Signs are:
Per Share Revenue: Growth slow down
First Solar Inc. revenue growth has slowed down over the past 12
months.
Operating Income: loss
First Solar Inc. had operating losses over the past three years.
With all these warning signs, it is no wonder that legendary
short-seller Jim Chanos shorted the stock. The stock lost more
than 90% over the past three years, and Jim Chanos made a fortune
out of it.
The warning signs have usually long been there with these
companies. The companies with a large number of warning signs at
high valuations are usually good short candidates. We will
discuss this more in the next article.
Paying attention to Warning Signs will help investors to avoid
value traps. As we discussed in
A Simple Way to Spot Value Traps
, we pointed out that profit margin decline is usually a warning
sign of a value trap. We used Nokia (
NOK
) as an example. The stock has lost more than 90% in the past
five years.
Warning Signs with Nokia (
NOK
)
Altman Z-Score: Distress
Altman Z-score of 1.34 is in distress zone. This implies
bankruptcy possibility in the next two years.
Piotroski F-Score: Low
A Piotroski F-Score of 2 is low, which usually implies poor
business operation.
Interest Coverage: Extremely low
Ben Graham prefers companies' interest coverage be at least 5.
Nokia Corporation (adr)'s earnings cannot cover its interest
expense. If the situation continues, the company may have to
issue more debt.
Per Share Revenue: Declined
Nokia Corporation (adr) revenue has been in decline over the past
three years.
Gross margin: Declined
Nokia Corporation (adr) gross margin has been in long-term
decline. The average rate of decline per year is -2.6%.
Operating margin: Declined
Nokia Corporation (adr) operating margin has been in long-term
decline. The average rate of decline per year is -30.7%.
Long-Term Debt: Keep issuing new debt
Nokia Corporation (adr) keeps issuing new debt. Over the past 3
years, it issued $235.32 million of debt.
Many of these Warning Signs have been there for many years. If
investors were aware of these Warning Signs, they would have
avoided the large losses with the stock. Similarly with:
RadioShack (
RSH
):
Gross margin: Declined
RadioShack Corporation's gross margin has been in long-term
decline. The average rate of decline per year is -2.2%.
Operating margin: Declined
RadioShack Corporation operating margin has been in long-term
decline. The average rate of decline per year is -2.8%.
Again, you need to be aware of the Warning Signs with companies.
Doing this can help you to find out what you may have overlooked
and avoid large losses. Sophisticated investors may use Warning
Signs to screen good short candidates.
Warning Signs is a feature for GuruFocus Premium Members. If you
are not a Premium Member, we invite you for a
7-day Free Trial
.
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