Is it possible to see a corporate train wreck before it happens?
Absolutely, says our weekly guest, Glen Wood.
He's Professor of Business at Broome Community College and President of The Glen Wood Financial Group.
We can watch a company's activities and financial statements. At the top of the list is a company's "life-line", it's called "Cash Flow". If a company's cash payments are more than its cash income, the company is said to have a "Negative Cash Flow". If this happens over a sustained period of time, a company can't meet its obligations and can go insolvent!
Which can mean it goes out of business.
What else should we be looking at?
Second, take a look at the company's "Debt" and its ability to pay "interest" on that debt. Interest "re-payments" obviously put pressure on our friend "cash flow". If the company's "Operating Income" is not a sizeable multiple of the interest payments, the company can again run into trouble. So look at a thing called the "Interest Coverage Ratio" and it should typically be 5 or better.
So that means that the company's operating income would be able to pay its interest debt 5 times over!
That's right and the higher the better.
Well the third thing to look at is obvious. Watch out for unusual "share price declines". Almost ALL corporate collapses are preceded by a sustained share price decline. Both Enron and WorldCom's share price started falling 16 months before they went bust.
That makes sense. And I know you like companies with increasing profits.
I do. It goes back to the old saying "Earnings Drives Price". Which is why our next thing to be careful of is when a company declares a thing called a "Profit Warning". It means they're probably going to miss the mark of previous estimates of their earnings.
And the price is likely to go down.
Quite likely and it could be swift and brutal or gradual and continual if the market under-reacts to the bad news.
And we have one more thing to look at.
We do; watch what the company's high level executives and directors are doing. They have the inside information on the company. If they're buying, that's usually a very good sign. If they're selling, it's time to take a closer look at the company.
Glen, where can we get the kind of information in tonight's tip.
Lots of free places on the internet! One good one is cnnmoney.com.
Bottom line; DO YOUR HOMEWORK! Thanks Glen.