Red Flags that Mean Sell as Soon as Possible

evaluating an ipo

Every investor that’s traded stocks for a while knows the feeling of watching a stock suddenly and unexpectedly drop overnight. One minute, you’re looking at solid fundamentals and making a case for why the stock could move higher and, the next, you’re watching investors dump shares in a panic while the stock drops to gut-wrenching levels.

There’s good news though – oftentimes these seemingly unexpected events can often be predicted by following up on certain tell-tale red flags. You can’t just buy-hold-and-ignore your stock picks. It’s important not only to pay attention to recent news and events, but be familiar with how to read financial statements. Most of the time, this is where you’ll find hidden red flags that let you know a stock should be avoided.

Watch for the signs

There are a number of things that can come up in a stock that should immediately alert investors that something is going terribly wrong. While many can be found in financial statements, other things, like unexpected events, need to be taken into consideration. Any reports of accounting manipulation or mismanagement should be easy red flags, but usually the signs are available beforehand for those who know what to look for.

One of the easiest red flags to spot is companies that have several consecutive earnings misses. Missing a quarter once in a while is normal and can be attributed to any number of things, like mergers, acquisitions and more. But missing several quarters in a row tells you that something is wrong with the company and it’s not being corrected.

Another more subtle red flag is rising account receivables or inventories. This trend can be a sign of financial manipulation – a reason for immediate selling – or that something is wrong with sales. Consumer tastes may be changing and the company isn’t keeping pace or the product isn’t in high demand anymore, leading to an increase in inventories. If inventory is growing faster than sales, it’s time to get out.

Finally, one-time line items should be viewed skeptically. These items might read as restructuring costs, which can mean the company is aware of its own financial difficulties and is trying to delay revealing it. Many times, a history of one-time charges is actually a recurring trend and investors could be holding a ticking time bomb.

While these red flags almost always spell disaster for a stock, it doesn’t mean there aren’t other hidden dangers masquerading as something innocent. Even the most experienced investors and analysts can be fooled. Staying diversified is the best defense against uncertainty. Even if the worst happens to a stock, if it’s only a small part of a larger portfolio, you can escape catastrophic losses.