New Feature Announcement: The Warning Signs

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GuruFocus
Aug 08, 2012
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GuruFocus has just released a feature called Warning Signs. We conducted 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, Financial) is below:


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The purpose of Warning Signs is to warn you that the company may have red flags in certain areas, helping to avoid overlooking them. 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):

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 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, Financial) as an example. The stock has lost more than 90% in the past five years.


Warning Signs with Nokia (NOK, Financial)

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. Similarly with:


RadioShack (RSH, Financial):

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 of 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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